Time to move on

1. A new mutual fund scheme called dream come true has been launched.
2. It raises Rs 1000000/- from the public.
3. This money is divided into units of Rs 10 each. Thus it issues 100000 units.
4. It invests Rs 1000000/- in two stock A and B each, whose market value is Rs 500 and Rs 1000 each. Thus it invests in 1000 shares of A and 500 shares of B.
5. Assume after three month market value of A is Rs 550/- and B is Rs 1100/-.
6. Now the market value of the entire investment is 1000 * 550 + 500 * 1100 = Rs 1100000/-.
7. Fund incurs an expenditure of Rs 25000/-.
8. Now the value of units is (market vale of investments – expenses / Total no of units)
9. 1100000 – 25000 / 100000 = Rs 10.75 per unit.
10. Rs 10.75 are called the NET ASSET VALUE (NAV) of the unit.
11. If some body invest Rs 100000/- in the fund. He will receive Rs 107500/- after three months (NAV*No of units).

There are two types of scheme in mutual funds

• Open Ended Schemes
  
• Close Ended Schemes
  

Open Ended Schemes

1. Units can be bought from and sold to the fund house issuing the fund at any time. For example Franklin India Blue Chip Fund. Unit will be issued at the NAV as on the date of purchase.
2. It means we can buy or sell any time from the fund house.

Close Ended Schemes

1. The fund house issues units only during a particular period. For example PRU ICICI Infra Fund.
2. After the initial issue the fund house does not routinely buy or sell units.
3. These units are listed in the stock exchange. Rarely a fund house buys back units from the market.
4. It means we can sell these units through stock exchange and not to the fund house.

Both (Open and Close Ended Schemes) can fall into following categories.

1. Equity Diversified Schemes
2. Equity Linked Savings Schemes
3. Balanced Schemes
4. Debt Fund Schemes
5. Liquid and Money Market Schemes

Investment is predominantly in equity shares. Investment is done of companies belonging to different sectors to diversify the risk. These schemes have the potential to deliver high returns but the risk is also high. For example Reliance Vision Fund. They have two types as follows

· Dividend Option

Here regular payouts are made to the investor based on the gains made by the fund. Some portion of the gain is paid as dividend.

· Growth Option

Here the fund reinvests the gains made and does not pay them as dividend. Purpose is to achieve long term capital appreciation. They do not have any lock in period. Units can be bought and sold at any time.

Equity diversified scheme are not eligible for Sec 80C benefits. Gains from these funds becomes taxable @ 10% if they are sold within one year of the purchase. Gains are exempt from tax if the units are sold after one year of purchase.

Equity Linked Savings Schemes

1. These are only class of mutual funds eligible for Sec 80 C benefits.
2. At least 90% of the corpus has to be invested in equity.
3. Investment has to be locked in for a minimum of 3 years.
4. Lock in of these schemes is different from that of a insurance scheme. If an insurance scheme has a lock in of 3 years, only the first premium gets locked in for 3 years.
5. If investments are made in the year 2005, 2006, & 2007, the entire amount can be withdrawn in 2008.
6. Under ELSS the investment made in 2004 can be withdrawn in 2008 amount invested in 2006 can be withdrawn only in 2009 and amount invested in 2007 can be withdrawn only in 2010. Effectively under ELSS lock in works out to be higher.
7. Investment in these schemes is eligible for benefit under section 80C.
8. Gains form these funds becomes taxable @ 10% if they are sold within one year of purchase.

Balanced Schemes

1. These funds invest part of their funds in equities and the rest in debt. Purpose is to achieve moderate capital appreciation, capital preservation and reasonable current income.
2. Less risky compared to equity funds, returns also are lesser.
3. Ideal for investors who want to enjoy the benefits of equity and at the same time want some protection against the down side.
4. For example HDFC balance fund.
5. These schemes are not eligible for Sec 80C benefits.
6. Gains are exempt from tax if the units are sold after one year of purchase provided investment in equity is at least 65%. Otherwise gains are taxed at 10%.

Debt Funds Schemes

1. Invest in debt instruments of government, private companies, banks, financial institutions etc.
2. Low risk as investments are made in fixed income generating instruments.
3. Expected return is also moderate. These schemes generate stable current income.
4. For example Birla Bond Index Fund.
5. No benefits Under section 80 C.
6. Gains are exempt from tax if the units are sold after one year of purchase.

Money Market Mutual Funds

1. Investments made in short term debt instruments with a maturity of less than one year.
2. For example short term government securities, investment with the banks for short term.
3. These funds are very liquid and are relatively safe. The returns generated are very low.
4. Gains are exempt from tax if the units are sold after one year of purchase.
5. Dividend distributed by these funds becomes taxable @ 28% in the hand of the fund itself.

Charges in Mutual Funds

· Entry load

This is a charge which is levied on the investor at the time of entry to the scheme. Usually this is 2.25% of the amount invested in most of the funds. It means if you invest Rs 10000/- in Mutual Fund, you have to pay immediately 2.25% of Rs 10000/- that is Rs 225/-, Rs 9775/- will be invest in mutual fund.

· Fund Management Charges

This is a fee levied for managing the funds of the investor. This charge is usually 2.25% every year for equity funds, as equity investment requires more research and monitoring compared to debt funds. Fund management charge is lived as 2.25% of NAV.

Steps in calculating tax—

• Classify the receipts into one of the five sources.

• Collect information on all the receipts both cash and other source of income. (income from lottery)

• Deduct exemptions allowed from each source of income. (Medical allowance exempt up to Rs 15000/-)

• Add taxable portion of income from all sources.

• Calculate tax based on the prevailing rates and also depending on weather male below 65, female below 65 or a senior citizen.

• If the income is above Rs 1000000/- add surcharge @ 10%.

• Calculate education cess @ 3% on the tax payable including surcharge.

Tax slab for Man

Tax slab for Women

Tax slab for Senior Citizen

Tax Savings under Sec 80 C

• Premium paid towards life insurance.

• Equity linked savings scheme of mutual fund.

• National savings scheme.

• Tuition free paid on children’s education up to two children.

• Public provident fund.

• Bank fixed deposits with a tenure of 5 years or more.

• Principal on housing loan.

• Recognized superannuation fund.

• Specified infrastructure bond.

Tax Savings under Sec 80 CCE

• In this section the maximum allowable deductions for investments made under section 80C and 80CCC (pension) taken together is Rs 100000/-.

• Maximum deduction for 80C + 80CCC is Rs 100000/- with no internal break up limit.

Tax Savings under Sec 10 (10D)

• Proceeds from an insurance policy including the gain made are tax free provided that sum assured is at least 5 times of premium.

• In case this condition is violated then the entire proceeds becomes taxable as income from other sources. Proceeds form a key man insurance policy is taxable.

For Example

Solution

Calculate total tax

Note

• Maximum exempt amount is Rs 15000/- for medical allowance under section 80D but you need to furnishes all medical bills.

• Maximum exempt amount is Rs 9600/- for transportation allowance.

• Surcharge @ 10% incase of total income is more than 10 lakh per annum.

• Education cess @ 3%.