Should I pay more tax if my fund’s equity holdings drop below 65%?

Published: July 17, 2020 at 11:07 am

“I checked the monthly fact sheet of my equity mutual fund and found that the equity allocation was less than 65% of domestic equity shares. Does this it will be classified as a debt mutual fund and I have to pay more tax on it?”.  A discussion.

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Let us start with the exact definition of an equity-oriented fund: “Investor may please note that the taxation of an equity-oriented scheme will be applicable to the scheme only if the scheme assets are invested in the equity shares of domestic companies to the extent of more than 65% of the total proceeds of the fund. The percentage of equity shareholding of the fund shall be computed with reference to the annual average of the monthly averages of the opening and closing figures. In any other case, the taxation of other than equity oriented scheme will be applicable”. Source: scheme document SBI Dynamic Asset Allocation Fund. Thanks to Dr Ramesh Mangal for pointing this out.

Should I pay more tax if my fund’s equity holdings drop below 65%? Even if the equity allocation is less than 65% for one month, it is the annual average of the monthly allocation that matters. The tax status is determined on the basis of this annual average. The tax status can change when you remain invested. Only the tax status in the month of redemption determines the nature of the fund and the tax you need to pay.

For the SBI fund, this annual average is computed on a monthly basis and the tax status data is available for the last five years. he reason being the fund has an asset allocation policy in which the equity holding can swing from 0 to 100% and fixed income from 100% to 0%.

The presentation document of SBI Dynamic asset allocation fund presents nice examples of how this rule works.  Two screenshots are shown below. Note: tax rules on equity funds have changed since this presentation was made. So kindly ignore the actual tax rate shown.

Tax status clarification for SBI Dynamic Asset Allocation Fund
Tax status clarification for SBI Dynamic Asset Allocation Fund
Tax status illustration for SBI Dynamic Asset Allocation Fund
Tax status illustration for SBI Dynamic Asset Allocation Fund. Tax rules on equity funds have changed since this presentation was made. So kindly ignore the actual tax rate shown.

Key takeaways: If we invest in such a dynamic asset allocation fund and it says so in its investment strategy that equity allocation can reduce below 65%,  then the tax status of the scheme in the month of redemption must be ascertained – hopefully other AMCs would also publish status data like SBI.

Then the tenure of holding should be calculating and suitable long term or short-term capital gains tax paid as per the tax status of the scheme – equity or debt. For dividends, the tax status on the record date of the dividend should be used. 

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