6.1  Net Assets/Net Assets Value (NAV) of Scheme

6.1.1  What is Net Asset/Net Asset Value?

  • The Unit holder’s funds in the Mutual Funds Scheme is the Net Assets of the scheme. The assets of the scheme are the investments held by it. This, along with the accrued income like dividend or interest due and Receivables constitute the Net Assets. Income due on securities held in scheme portfolio are considered whether received or not. Short term liabilities like accrued expenses and payables for securities bought are the scheme liabilities. Total assets minus such liabilities are the net assets of the scheme.
  • Therefore, net assets include the amount originally invested by the scheme of mutual fund, the profits booked as well as the appreciation in the portfolio. Net assets increase when the market price of securities held in the portfolio increases. It increases even if the investments are not sold or profits still not realised.
  • While calculating Net Assets, Income and expenses of the scheme have to be accounted for on the basis of principle of accrual.
  • NAV refers to the value of each unit of scheme. It is equal to Unit holder’s fund in the scheme (Net Assets) divided by number of outstanding units.

6.1.2. What does the NAV reflect?

  • NAV can be summarised as (Current value of investments held + Income accrued+ Current Assets – Current Liabilities- Accrued Expenses)/ Number of Outstanding Units).
  • The NAV reflects actual worth of each unit of scheme based on current market value of scheme portfolio. The process of valuing each security in the investment portfolio at its current market value is called “Mark To Market”. If this principle is not followed, then investment portfolio will end up being valued at cost. This will therefore become meaningless for the investor.
  • Issuing fresh units at prices lower than NAV will result in post issue NAV coming down for all investors. Similarly, redeeming units at prices lower than the NAV will increase the NAV for the remaining unit holders.

6.2  Sale Price, Redemption/Repurchase Price of Units and Loads

6.2.1  What is Sale price and Redemption/Repurchase of Units?

  • In open ended schemes, there is a facility for the investors to acquire new units from Mutual Fund (“sell” transaction). Units can also be sold back to the scheme which is called “Repurchase transaction”. Repurchase is also called redemption by the scheme.

6.2.2  Charges and Loads

  • When sale price is higher than NAV, the difference between sale price and NAV is called “Entry Load”. When Repurchase price is lower than the NAV, the difference between Repurchase Price and NAV is called Exit Load. Generally, exit load of scheme is pre-defined. Calibrated exit loads depending on the holding period are called “Contingent Deferred Sales Charge”. Entry loads are, however, banned now. So, sale price needs to be same as NAV.
  • Any fresh imposition or enhancement in exit load can only be prospective. Earlier schemes could differentiate between different classes of investors within the same scheme. It was done by charging them different levels of load. However, presently this is not permitted. The parity among shareholders on exit load is applicable at portfolio level. No exit load is applicable on Bonus units and units allotted on reinvestment of Dividend.
  • Interms of SEBI circular effective 20th October’2019, In case of Liquid and Overnight funds (Where the exit load was hitherto NIL), graded exit load for holding period from Day 1 to Day 6 will be applicable ranging from 0.0070 % to 0.0045% of the redemption proceeds.
  • Exit loads / Contingent Deferred Sales Charge will be credited to the scheme It will not be available for AMC to utilise the same to bear various  selling expenses.

6.3  Scheme Fees and Expenses

6.3.1  Expenses Allowable against the scheme

  • Fund management and running expenses can be charged to scheme. SEBI has specified the type and limit of such expenses. Such Expenses like Fees to Registrar/Transfer Agents, fees to Trustees, custodian and auditor, Brokerage, marketing expenses, commission to distributors, Investor communication expenses, Listing and depository fees, Insurance premium, Investment fees and advisory fees, winding up cost of scheme incurred by AMC are chargeable to scheme.
  • In case of Capital Protection Fund, the cost of Credit Rating is an allowable expense. In case of Real Estate funds, the cost of maintenance and insurance of Real Estate assets is allowed. In case of Gold ETFs, cost of storage and handling of gold can be charged to scheme expenses.
  • There are no sub limits for these expenses within the limit of overall expense ratio.

6.3.2  Expenses not allowable against the scheme

  • Initial issue expenses are incurred at the time of the launch of scheme in a new fund offer (NFO). These are borne by AMC and not charged to scheme.
  • The expenses which are not allowed to be charged to scheme are to be borne by the AMC or by sponsors of MF. Expenses like Fines and Penalties for violation of any law, interest on delayed payments, Legal/marketing /advertisements and other general expenses which are not specifically attributable to any specific scheme, Fund accounting fees, general administrative expenses, corporate advertising, Infrastructure cost, Depreciation on Fixed assets and Software Development expenses can  not  be charged to scheme.
  • Management Fees cannot be charged by liquid schemes and other debt schemes on funds parked in short term deposits of commercial banks.

6.3.3  Total Expense Ratio (TER)

  • The total expense of the scheme will be within the limits as specified. For Index  Fund scheme or ETF, the limit is 1% of daily net assets. In case of close ended funds and interval fund, TER for equity oriented scheme will be  maximum 1.25% and for other schemes, maximum TER will be 1%.
  • For any other scheme, total expense limit has been specified by SEBI as follows:

AUM (Rs. Crore)TER for Equity-Oriented SchemesTER for Debt-Oriented Schemes
0 – 5002.25%2.00%
500 – 7502.00%1.75%
750 – 20001.75%1.50%
2,000 – 5,0001.60%1.35%
5,000 – 10,0001.50%1.25%
10,000 – 50,000TER reduction of 0.05% for every increase of 5,000 crore AUM or part thereofTER reduction of 0.05% for every increase of 5,000 crore AUM or part thereof
Greater than 50,0001.05%0.80%

An additional TER (Total Expense Ratio) up to 30 basis points can be charged on daily net assets of the scheme  based on inflows from retail investors from beyond Top 30 cities (B 30 Cities). Inflows from corporate and institutions will not be considered for the purpose of the said additional TER. Brokerage out of this TER for B 30 cities will be paid to the distributors on trail basis only.

  • Expenditure in excess of total expense ratio limit has to be borne by the AMC, Trustee or Sponsor of MF.
  • AMCs need to disclose Total Expense Ratio (TER) of all the schemes under a separate head on a daily basis on the website of their own and that of AMFI. Any Change in base TER is to be communicated to the investors of the scheme through email or SMS at least three working days prior to effecting the change. However notice of  any reduction in TER is not mandated to be conveyed to the investors, before effecting the change.
  • AMCs can charge GST, as per applicable laws, to the schemes within the prescribed limits under SEBI (Mutual Fund) Regulations.

6.3.4  Dividends and Distributable Reserves

  • SEBI guidelines provide for dividends to be paid out of distributable reserves.
  • For ascertaining distributable reserves, all the profits earned based on accrual system of accounting are considered as available for distribution. Valuation gains are not considered. But valuation losses need to be adjusted against the profits.
  • It is thus ensured that dividend is paid only out of real and realised profits, after providing for all possible losses.
  • Neither rate nor quantum of dividend can be guaranteed or assured to the investors.
  • The trustees shall decide the quantum of dividend and the record date. Within one day of trustee’s decision, the AMC shall issue a public communication. It will give details of dividend and record date. The record date will be five calendar days from issue of the notice by AMC. Public notice will convey that NAV of the scheme will fall pursuant to dividend pay-out and any statutory No notice is required for debt schemes with already declared frequency of dividend pay-out – from daily to monthly basis.

6.3.5  Accounting & Reporting

  • Accounts and auditors for the scheme will be different from those of AMC.
  • Norms are specified as to when Interest, Dividend, Bonus issues, Right Issues etc should be reflected and accounted for in the accounts.
  • NAV for Index Funds, Liquid Funds and other debt funds is to be calculated up to Four decimal places. NAV for Equity and balanced funds is calculated up to at least two decimal places. Investors can hold their units in a fraction of 1 unit also. However current stock exchange trading systems may restrict transacting on the exchange to whole units.

6.4  Valuation of Securities

  • In order to determine the NAV of the scheme, the valuation of securities in scheme portfolio has to be done. It is done in accordance with the SEBI and AMFI norms.
  • Security will be valued at the last quoted closing price on the principal stock exchange where it is traded. If the security is not traded on a particular date, then it will be valued on the closing price at which it was traded on the earliest previous day. The last trade should not be more than 15 days old for Debt Security (other than G Sec) and 30 days for Other than Debt Security.
  • All Money market and debt instruments with residual maturity up to 60 days shall be valued at the weighted average price on the valuation date.
  • A security which has not been traded for thirty days prior to the date of valuation is considered as a non traded security. A thinly traded security is one where the volume traded is less than 50,000 and value traded is less than Rs Five Lakhs in a month.
  • A non-traded or thinly traded equity security may be valued using the capitalisation of earnings method. It will use the P/E ratio of comparable traded securities. It will give appropriate deduction for liquidity.
  • A non-traded or thinly traded debt security is valued on the basis of the yield matrix prepared by an authorised valuer. It should be based on credit rating of the security. When a money market/debt security with residual maturity up to 60 days is not traded on the particular day, it will be valued on the basis of amortisation.
  • Norms have been prescribed for treating a security as a Non performing assets (NPAs). Norms have been prescribed to ascertain when and how much of the NPA  can be written off from the portfolio. Similarly, norms have been prescribed  when the NPAs can be restored to portfolio after becoming standard assets.
  • An independent valuer will be appointed when a non traded or thinly traded security forms more than 5% of the net asset of the scheme.
  • Illiquid securities shall not exceed 15% of the total assets of the scheme. No value will be assigned to any excess over 15 percent.
  • Norms for valuing gold held by any ETF have also been prescribed. CRISIL and ICRA have been appointed by AMFI to provide security level pricing of fixed income securities having maturity over 60 days to ensure uniform valuation by AMCs.

6.5  Taxation of Mutual Funds/MF Investors

6.5.1  A mutual fund trust is exempt from tax on its income and earnings under section 10(23) of the Income Tax Act. Since the returns of the mutual fund are passed on to its investors, the returns are taxed in the hands of the investor. Tax liability of investor will depend upon the type of investor, type of mutual fund scheme and period of holding.

Mutual Fund Scheme having at least  65% investment  in equity shares of domestic companies  of the its  portfolio is considered as Equity Oriented Scheme for taxation purpose. All schemes, other than Equity Oriented Schemes, are treated as Debt Schemes for the purposes of Income Tax. Infrastructure Fund Schemes are however treated differently for Income Tax purpose.

6.5.2  Securities Transaction Tax (STT)

STT is not applicable to transactions in debt mutual fund schemes.

STT is not applicable on purchase of units of an equity scheme.

STT is applicable on the investors @.001 percent only on redemption / switch to other schemes / sale of units of equity oriented schemes whether transacted  on stock exchange or through mutual fund.

6.5.3  Dividend Distribution Tax (DDT)

Dividend received by the investors of mutual fund is tax free. However, Mutual Fund has to pay Dividend Distribution Tax on dividend distributed by its  equity and debt schemes.

DDT  is payable as under:

For Equity Oriented schemes for all types of investors: 10% plus 12% surcharge plus 4% cess.

For Debt schemes (other than Infrastructure Debt Fund):   

(A) If investor is domestic company/Firm – 30% plus 12% surcharge plus 4% cess.

(B) For Individual/HUF investors – 25%  plus 12% surcharge  plus 4% cess.

For Infrastructure Debt Fund:

(A) If investor is domestic company/Firm – 30% plus 12% surcharge plus 4% cess.

(B) For Individual/HUF  investors – 25%  plus 12% surcharge  plus 4% cess.

(C) For NRI  investors – 5%  plus 12% surcharge  plus 4% cess.

6.5.4  Capital Gains Tax-

  • Capital Gain can be defined as the difference between sale price and acquisition cost of the investment. Investors need to pay tax on their capital gains as follows:

Equity Oriented Schemes

Short Term Capital Gain @ 15% plus surcharge plus cess for investment held for 12 months or less.

Long Term Capital Gain @ 10% plus surcharge plus cess for investment held for more than 12 months. Long term capital gain Tax will be applicable on gains exceeding Rs 1 lac in a financial year at the rate of 10% (Without Indexation benefit). However, all long-term capital gains upto 31st january’2018 have been grandfathered.

Debt Schemes

Short Term Capital Gain for investment held for 36 months or less – (a) for Individual / HUF / NRI, tax will be at the rate which is applicable to him as per his income slab, (b) for Domestic Company/Firm, tax rate is 30% (25% in case of companies whose turnover during Financial Year 2016 – 17 does not exceed Rs. 250 crores).

Surcharge and cess wherever applicable will be extra.

Long Term Capital Gain, after indexation, @ 20% plus surcharge plus cess for investment held for more than 36 months for all types of investors except unlisted NRI. For unlisted NRI, it will be at 10% plus surcharge plus cess, without indexation.

Short term / long term capital gain tax plus applicable surcharge plus cess  will be deducted at the time of redemption of units in case of NRI investors.

6.5.5  What is Indexation

  • Government of India declares Cost Inflation Index number in each financial year for various statistical purpose.
  • This index number is taken into consideration for calculation of tax on long term capital Gains of a mutual fund scheme other than the equity fund schemes.
  • This is a tool to balance the effect of inflation on the earnings gained by non-equity fund investor.

6.5.6  Tax Deducted at Source (TDS)

TDS (Tax Deducted at Source) is not applicable in case of dividend paid to resident investors. Similarly, TDS is not applicable in case of redemption / repurchase proceeds to resident investors. However, for certain cases of non resident investments, TDS is applicable.

6.5.7 Set Off of Capital Gains/Losses

  • As per prevailing provisions of IT Act, Capital Loss, whether Short Term or Long Term, can not be set off against any other head of Income.
  • Short term capital loss could be set off against short term capital gain or long term capital gain.
  • However, Long Term capital loss could be set off against long term capital gains only.

6.5.8  Dividend Stripping / Bonus Stripping

  • When a dividend is paid, the NAV (Ex Dividend NAV) goes down.
  • This dividend is exempt from tax in the hands of investor.
  • Capital loss may be available for set off against Capital Gains.

Some times, investors make investment and within a short span of time, dividend is declared. After record date of dividend, NAV of the scheme goes down. Very shortly after the record date, they redeem the investment at ex dividend NAV. Ex dividend NAV, in normal circumstances, becomes less than NAV at which investment was purchased. With this strategy, they take dividend which is tax free and then they book short term capital loss to set off against short term capital gain. This is known as dividend stripping. To curb the misuse of dividend stripping, it is provided in income tax act, that:

If an investor buys units within three months prior to record date for a dividend, and sells those units within nine months after the record date, any capital loss from the transaction would not be allowed to be set off against other capital gains to the extent of value of dividend exempted.

Same rule apply in case of Bonus Stripping also.


Quick Revision

[WATU 13]

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