Here is how Franklin Segregated Portfolio (Vodafone) payout will be taxed

Published: July 14, 2020 at 7:34 am

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Franklin Templeton AMC has received 1252.44 crores from Vodafone Idea towards full principal and interest dues for the period June 12 to July 9, 2020. The AMC will now close the segregated portfolios (side-pocket) and payout investors. Here how this payout will be taxed. Thanks to an amendment in budget 2020, the taxation of segregated portfolios is now clear.

As readers may recall segregated portfolio were created with effect from Jan 24th 2020 after the bond issuer was downgraded to “below investment grade”. The funds affected were Franklin India Low Duration Fund, Franklin India Dynamic Accrual Fund, Franklin India Credit Risk Fund, Franklin India Short Term Income Plan, Franklin India Ultra Short Bond Fund and Franklin India Income Opportunities Fund.

For those who wish to know the basics of side-pocketing or segregated portfolio creation can consult this: What is a ‘side-pocket’ in mutual funds? How does it work? Franklin had marked down the Vodafone bonds a few days before the creation of the side-pocket.

Note:  A general example is first shown. The reason why Franklin mentioned “cost of acquisition is zero” is explained at the of the article.

Take the case of Franklin Ultra Short Bond Fund. Its NAV fell by Rs. 1.2349 per unit on 16th Jan 2020. For illustration, we shall use this as the NAV of the segregated portfolio (the real NAV of the side-pocket will be different, please check your account statements).

The NAV on 15th Jan 2020 was Rs 28.3446 per unit. So 1.2349/28.3446 = 4.4% (approx) of the AUM was side-pocketed. Now how is this payout taxed?

Suppose an investor purchased units on 1st June 2017 at a NAV of say Rs. 22.5 per unit. The date of purchase (acquisition) of Vodafone side-pocket payout will be 1st June 2017. The purchase value (cost of acquisition) is 4.4%x 22.5 =Rs. 0.98 per unit (approx).

Date of the payout (redemption) is say, July 20th  2020 at the NAV of Rs. 1.2349 then the gain per unit is Rs. 0.255. The total gain is the no of units held in the segregated portfolio x 0.255.

Since more than three years have passed since the purchase of the units, this will qualify as LTCG. First, the purchase price has to be inflated using the cost inflation index (indexation) and then 20% tax  + cess of 4%* will have to be paid on the effective indexed gain. See this article for examples: How indexation benefit lowers the tax on debt, gold & international mutual funds

If the initial purchase was made less than or equal to three years from the date of payout, the gain becomes short-term. It will have to be added to income with tax as per slab. The above is only an example. Please use your account statements for the actual calculation.

Update:  I was informed that the NAV of the segregated portfolio was zero when created(!!) and it has now become Rs. 1.432. The math in this article is correct. Just that now the cost of acquisition is zero. Cost of redemption is Rs. 1.432. Since the cost of acquisition is zero no indexation would apply. The gain per unit is Rs. 1.432. This would be taxed ar 20% + cess in the case of LTCG and as per slab in the case of LTCG. Thanks to Kranti Goyal and @harsha_hs on Reddit for pointing this out.

*A surcharge of 10% would apply if the unitholders income is bet 50-100lakhs and 15% if it is more than 100 lakh. Thanks to Manmohan Sethumadhavan for point this out.

Reference: Extract from Budget 2020 Memorandum (page 31)

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