Fund houses to shell out 14% tax on balanced MFs

BUDGET: THE DAY AFTER

Fund houses will soon have to shell out a 14 per cent dividend distribution tax on their balanced mutual fund schemes and also take the hit of the long-term capital gains tax due to the change in the definition of equity oriented funds in the Union Budget.

To be termed as "equity oriented funds", funds will now be required to invest more than 65 per cent in equity shares compared with 50 per cent in the existing definition.

This is expected to disqualify a majority of the balanced funds, including Templeton India CAP Gift Plan, Prudential ICICI Child Care - Gift, Birla Asset Allocation Moderate, Sundaram Balanced, Principal Child Benefit, HDFC Children's Gift, ING Vysya Balanced, and UTI Balanced, fund from tax benefits.

As many as 18 of the 28 balanced funds had equity portfolio of less than 65 per cent as on January 31, 2006. As many as eight of the funds have a mandate as per their offer documents to invest more than 35 per cent in debt instruments. The amended definition is set to be effective from June 1.

"This announcement is a negative step. Balanced funds generally invest about 40 per cent in debt. If the fund houses increase the equity allocation simply to qualify for tax benefits, it increases the risk for investors," Dhirendra Kumar, chief executive, Valueresearch, which tracks the mutual fund industry, said.

Under the existing provisions, the dividend distribution tax is not payable by any open-ended equity-oriented mutual fund. The exemption from long-term capital gains tax is also granted to equity-oriented funds.

The effective dividend distribution tax adds up to 14.025 per cent after adding the 10 per cent surcharge and 2 per cent education cess.