| Avoid Tax through Systematic Withdrawal Plans |
Most MF industry watchers predicted the doom for Debt funds when the tax on dividends declared by Income and debt funds was raised to 22% in the last Union Budget. But nothing of that sort has happened. Incidentally income funds have seen better collections as compared to equity and growth funds. What has been the reason ? Have investors and ingenious fund managers found a smart way out of the tax tangle?
The answer is an emphatic Yes. The answer is very simple. As per the modified regulations only the tax rate of 22% applies only to dividends declared by the mutual funds. This can however be circumvented if the investor opts for a Systematic Withdrawal Plan instead of receiving periodic dividends since withdrawals tantamount to capital depletion and hence are not taxed in the same form as dividends. Although both dividends and systematic withdrawals actually mean partial liquidation of the fund capital for tax purposes they are treated differently. And it is this loophole that investors and savvy income fund managers have exploited to the hilt.
Let us understand the modus operandi of this tax saving means using a tabular comparison :
First let us look at a Systematic Withdrawal Plan which allows the investor to withdraw the entire capital appreciation through the Systematic Withdrawal Facility.
| Month | NAV | Monthly Drawal | Capital portion | Gain Portion | Tax on ST CG@34.5% | Amount Net of Tax | Units Redeemed | Units O/S | Value of Investment |
| 1 | 10.08 | 833 | 826.45 | 6.89 | 2.38 | 830.96 | 83 | 9917 | 100,000 |
| 2 | 10.17 | 833 | 819.62 | 13.72 | 4.73 | 828.60 | 82 | 9835 | 100,000 |
| 3 | 10.25 | 833 | 812.84 | 20.49 | 7.07 | 826.26 | 81 | 9754 | 100,000 |
| 4 | 10.34 | 833 | 806.12 | 27.21 | 9.39 | 823.95 | 81 | 9673 | 100,000 |
| 5 | 10.42 | 833 | 799.46 | 33.87 | 11.69 | 821.65 | 80 | 9594 | 100,000 |
| Grand Total | 35.26 | 4131.42 | |||||||
Now let us look at a Monthly Income Plan where the fund pays out the entire appreciation as the dividend and also pays the dividend tax on a monthly basis and then goes back to the ex-dividend price of Rs.10/- at the end of the month.
| Month | NAV Cum Dividend | Monthly Dividend | Tax on Dividend @ 22% | Amount Net of Tax | NAV Ex-Dividend | Value of Investment |
| 1 | 10.08 | 833 | 150.27 | 683.06 | 10 | 100,000 |
| 2 | 10.08 | 833 | 150.27 | 683.06 | 10 | 100,000 |
| 3 | 10.08 | 833 | 150.27 | 683.06 | 10 | 100,000 |
| 4 | 10.08 | 833 | 150.27 | 683.06 | 10 | 100,000 |
| 5 | 10.08 | 833 | 150.27 | 683.06 | 10 | 100,000 |
| Grand Total | 751.35 | 3415.30 | ||||
In the above comparison it is explicit that by opting for a systematic withdrawal plan instead of a Monthly Dividend Plan the investor can smartly reduce his tax outgo by paying tax only on the capital gains portion instead of the entire dividend. Investors would do well to adopt this smart approach and get investment savvy with Systematic Withdrawal Plans. Makes investment sense right. After all in the above example the tax outflow under the MIP is 20 times the tax outflow under the Systematic Withdrawal Plan for the first 5 months. Of course this advantage will diminish as time passes but it provides a good avenue for investors with a medium perspective to save on tax. So go ahead and get smart with Systematic Withdrawal Plans on Income Funds.
T S Harihar
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