The Securities and Exchange Board of India (Sebi) has asked fund houses to re-categorise their schemes to make it simpler for investors to understand and evaluate their investment decisions. As per the directive, equity mutual funds (MFs) are to be divided into 10 categories and debt funds into 16. Further, each fund house can only have one scheme in each equity and debt category.
Due to this many fund houses have started announcing the merger or consolidation of their schemes to comply with the Sebi directive. During such a merger, a switch from one scheme to another takes place, where an investor will incur either a capital gain or loss on such transaction. This is an important point to note because from April 1, 2018 a 10 percent (plus cess) tax will be levied on long-term capital gains (LTCG) made on the sale of shares and equity-oriented MFs.
Post re-categorisation of mutual fund schemes, many investors could face issues calculating LTCG for the purpose of taxation. Will investors be taxed even at the time of merger/consolidation of schemes? If not, how and when will LTCG be taxed? Read on to find out.
Capital gains on sale of units in a switch due to merger of schemes not taxable
As consolidation of schemes takes place, there is good news for investors. "Merger or consolidation of schemes in order to re-categorise existing schemes as per Sebi orders would not attract any capital gains tax, either short-term or long-term, in the hands of the investor. The government had already amended section 47 of the Income Tax Act to exempt the capital gains arising from the merger or consolidation of mutual fund schemes with effect from April 1, 2016," says Chetan Chandak, Head of Tax Research, H&R Block India says.
What this means is that when a scheme is merged, you will not be taxed on the long and short term gains you will make whenever you will sell the units.
Another good news is that merger of equity MFs will not affect the holding period of your investments in the scheme.
"In this case while calculating the holding period of an investment in order to ascertain the tax you are liable to pay on capital gains from it, the initial date of investment, i.e., the date when you first made the investment will be taken into account," says Subramaniam Krishnan, Tax partner, EY India.
However, LTCG tax will be levied when you will redeem your units after holding it for more than one year. Here is how it will be calculated.
LTCG at the time of redeeming your mutual fund investments
Assuming that the equity mutual fund scheme you have invested in has been merged with another to comply with the Sebi directive, how do you calculate LTCG/loss? For equity investments held till January 31, 2018 capital gains are grandfathered. Therefore, one has to calculate LTCG based on certain parameters. According to the rules, the cost of acquisition (CoA) in such cases will be taken as the higher of:
a) Actual cost of acquisition and
b) Lower of (i) Fair Market Value (FMV) on January 31, 2018 or (ii) actual sale proceeds
Grandfathering of long-term capital gains on equity MF units has given rise to two cases:
a) Equity schemes that are merged after February 1, 2018
b) Equity schemes that were merged before February 1, 2018
CASE A: Calculation of LTCG for equity schemes merged after February 1, 2018
Since the merger of schemes will be taking place after February 1, 2018, we have to consider two net asset values (NAVs). One NAV for units of the old scheme and the other for units of the new scheme.
Krishnan says, "To calculate LTCG accrued from the sale of merged mutual fund scheme units, one will take NAV of the old scheme as on January 31, 2018 to calculate the FMV. However, the units have to be adjusted proportionately, depending on the amount of units received on switch."
Krishnan explains this with an example: Say you invested a lump sum amount of Rs 1 lakh in December 2016 in Scheme A. The NAV of the scheme at the time of investment was Rs 20. The scheme got merged with scheme B in April 2018. Switch-out NAV of scheme A is Rs 40 and switch-in NAV of scheme B is Rs 100. You then sold your investment in June 2018 at an NAV of Rs 120.
ET OnlineHere we have assumed that FMV of scheme A is Rs 35 as on January 31, 2018 and FMV of scheme B as on January 31, 2018 is Rs 80.
Now to calculate LTCG in such a situation, Krishnan says FMV of Scheme A will be used. The calculation will take place as follows:
ET Online*LTCG up to Rs 1 lakh is ignored in both the cases
FMV in the above example has been calculated as: 35 X 2000 X (5000/2000). If only partial units are sold then, then you will have to substitute the number of units sold accordingly to calculate FMV, adds Krishnan. It is to be noted that here the FMV of scheme B plays no role because the calculation is based on the FMV of your investment as on January 31, 2018 which only relates to scheme A.
CASE B: Calculation of LTCG in equity schemes merged before February 1, 2018
The above mentioned scenario will be applicable to many investors as fund houses have started announcing the merger of their schemes to comply with Sebi's order. There might be some investors whose schemes were merged before tax on LTCG from equity mutual funds was announced on February 1, 2018.
Chandak says, "FMV of the new scheme as on 31 January, 2018 will be taken into account for calculating LTCG on equity mutual fund schemes that were merged before the announcement of the budget on February 1, 2018."
Here is how LTCG will be calculated in this scenario. Say you had invested a lump sum amount of Rs 1 lakh in December 2016 in Scheme A and NAV at that time was Rs 20. The scheme was merged with scheme B in February 2017.
As mentioned above, since there is a consolidation of scheme, the transaction will be considered as a switch. Switch-out NAV of scheme A is Rs 25 and switch-in NAV of scheme B is Rs 60. You then sold the units in April 2018 at an NAV of Rs 100.
ET OnlineAs per the rules mentioned above, to calculate FMV of such units, NAV of scheme B as on January 31, 2018 is required. Assuming NAV of scheme B as on January 31, 2018 is Rs 80, Chandak explains in such cases, the Cost of Acquisition (CoA) and tax on LTCG will be calculated as follows:
LTCG Calculation
ET Online*LTCG up to Rs 1 lakh is ignored in both the cases
What you should do
Mergers or consolidation can lead to change in the fundamental attributes and investment philosophy of the scheme. Therefore, you should not just consider the taxation angle when deciding on whether you should stay invested or not. See where all the 'new' avatar of the scheme will be investing now to take a call.
