Bonus mutual fund (MF) options have become quite popular in recent years with a large number of investors taking this route to make investments. Bonus units involve a component of tax benefit that the investors claim and although the Income-Tax Act has bonus stripping provisions in place, it does not seem to stop them from availing tax benefits. The Association of Mutual Funds in India (Amfi) has told its member MFs to refrain from accepting fresh subscriptions for bonus plans.
On Tuesday, Amfi issued a circular on best practices to this effect to all MF houses. If implemented properly, this move could have a big impact as far as investors are concerned.
Nature of plans
Mutual fund schemes come with a wide variety of options. While dividend plans give dividend either in the form of cash or additional units to the investor, there is no payout in case of growth plans. When it comes to bonus plan, the gains of the fund are given to the investor in the form of bonus units.
Bonus units mean free additional units, which don’t have much impact on the investor’s overall position because the net asset value (NAV) of the fund drops in a proportion that is identical to the ratio at which bonus funds are issued. For example, if the NAV of the fund is Rs 20 and the scheme announces a 1:1 bonus, an investor holding 500 units will have 1,000 units but at the same time the NAV will come down to Rs 10. So there won’t be any change in the overall value of the holdings.
Bonus stripping
The reduction in NAV can lead to capital loss for the investors. To actually claim this loss in their tax returns, investors need to fulfill a few specific conditions. First, the units have to be bought 91 days before the date of bonus. If not available, the units have to be held for a period of nine months after the bonus record date. This ensures that the investor does not come into the fund just for the bonus purpose.
Investors showed a lot of interest in such funds because many would buy the units just before the three-month period began ahead of the bonus date and then sell them after the bonus came into their accounts. This ensured that they got the benefit of returns as well as tax savings.
Amfi guidelines
Amfi has now urged mutual fund houses to stop such bonus plans as they were against the spirit of the guidelines that are in force. This is mainly because the fund houses had bonus plans in arbitrage funds, which were actually calculated as equity oriented funds. Hence they were able to ensure that the risk to the investors in bonus plan was limited, as arbitrage funds would not have the same downside risk as that of equity oriented funds. Yet, the benefits on the tax front would be available to investors.
It would be important to see how many mutual fund houses actually follow this guideline as it could have a significant impact on the nature of the options present for the investors.
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