Costs and Taxes Associated With Investing In Mutual Funds
01 Jun 2017
Priyanka Sharma
New Page 1
The best things in life are free. However,
realistically speaking, it may have some charges associated with it. Your child’s
laughter is free. However, if your child is not a kid anymore, the laughter would be
possible only if you bought them what they want. Your child could want a gaming console or
a foreign trip. The laughter, in this case, involves some monetary charges. This is also
true when it comes to Mutual Funds. You will get returns on your investment; however,
there are certain charges and taxes that would be levied.
Let’s glance at the charges and taxes that you will have to shell out when
investing in mutual funds.
Charges
1. Entry Load: The charges levied by an asset management company (AMC) when
you purchase a mutual fund is called Entry Load. This is a one-time charge. While this
charge could increase your buying cost, this has been abolished for Indians by Securities
and Exchange Board of India (SEBI).
2. Exit Load: This is the charge levied by the AMC when you sell off your units
before a stipulated time. This is also a one-time charge. From a broader perspective,
these charges favor you as an investor. Mutual funds use these charges as a deterrent so
that you do not exit the investment avenue without earning substantial profits. These
charges are also imposed to safeguard other investors who are with the fund for a longer
time as any investor’s exit could increase the cost for other investors. The exit
load is charged according to a pre-defined holding period cut-offs. The AMC may not levy
any charges if the fund’s objective is to be a short-term fund. The exit load is
usually between 1-3% depending on the exit timeline specified by the AMC.
3. Transaction Charges: Since 2011, SEBI has allowed AMCs to collect a nominal
charge if the investment is above Rs. 10,000. This is the final one-time
direct charge for now. If the investment amount is less than Rs. 10,000,
then no investment charge would be levied. The investment charges are Rs.150 for a new
investor and Rs. 100 for an existing investor. In case of systematic
investment plan (SIP), if your total investment is more than Rs.10,000,
a transaction charge of Rs.100 would be payable in 4 equal
installments.
4. Expense Ratio: The expenses incurred by the AMC are not borne by them; they are
borne by the investors. This is charged daily and the daily NAV is
adjusted accordingly. The charges that AMC can incur are fund management fees,
marketing/selling expenses, Audit charges, Registrar fees, Trustee fees and Custodian
fees. Of these charges, fund management fees and marketing/selling
expenses could be charged by the AMC at their own discretion. The other charges are the
actual expenses that the AMC will actually incur while managing the funds.
5. Other Indirect Charges: When an AMC proposes a new fund offer, it incurs certain
charges as well. These charges can be 6% of the total net assets and can be adjusted in
over a period of 5 years. There are other minor one-time charges when you invest in mutual
funds. If you invest in ETFs, you need to open an account. You will need to pay
maintenance charges and broker charges as well. Mutual funds are also required to pay a
security transaction tax while buying and selling stocks. This is also ultimately borne by
the investors.
Taxes
1. Tax Deducted at Source: Tax deducted at source or TDS is the tax that the
government collects on the returns on your investment. This is usually 10% of the returns.
There would not be any tax on the dividend distribution or re-purchase proceeds to Indian
resident investors.
2. Securities Transaction Tax: This tax is applicable only on funds dealing with
equities, derivatives and mutual funds. STT can be collected for selling and purchasing
through stock exchanges. STT is not applicable for debt, debt-oriented or commodities
mutual funds.
3. Dividend Distribution Tax: The dividend distributed by debt-oriented mutual fund
schemes is also taxed as dividend distribution tax (DDT). This additional tax is not
applicable for any equity-oriented funds.
4. Capital Gains Tax: The government levies capital gains tax on investments that
are supposed to be long term but are cashed in the short term. For equity-oriented
schemes, capital gains tax is not applicable if the fund is held for more than a year. For
debt-oriented scheme, there is no capital gains tax if the investment is held for more
than 3 years.
Bottom Line
As Albert Einstein famously said—The hardest thing in the world to understand
is the Income Tax. Thus, most charges and taxes can be difficult to understand. Now
that you know what are the taxes and charges associated when buying mutual funds, you can
make an informed decision.