Chapter 6. Accounting, Valuation & Taxation

Learning Objectives

Your learning of mutual funds is incomplete, if you do not know a few aspects of accounting of mutual fund schemes, valuation of securities in the scheme’s portfolio, calculation of net asset value, and the impact of taxation on various types of mutual fund schemes and investors in these schemes.

The unit-holders’ funds in the scheme is commonly referred to as “net assets”.

Net asset includes the amounts originally invested, the profits booked in the scheme, as well as appreciation in the investment portfolio. It goes up when the market goes up, even if the investments have not been sold.

A scheme cannot show better profits by delaying payments. While calculating profits, all the expenses that relate to a period need to be considered, irrespective of whether or not the expense has been paid. In accounting jargon, this is called accrual principle.

Similarly, any income that relates to the period will boost profits, irrespective of whether or not it has been actually received in the bank account. This again is in line with the accrual principle.

In the market, when people talk of NAV, they refer to the value of each unit of the scheme. Higher the interest, dividend and capital gains earned by the scheme, higher would be the NAV. Higher the appreciation in the investment portfolio, higher would be the NAV. Lower the expenses, higher would be the NAV.

The difference between the NAV and Re-purchase Price is called the “exit load”.

Schemes can also calibrate the load when investors offer their units for re-purchase. Investors would be incentivized to hold their units longer, by reducing the load as the unit holding period increased. Such structures of load are called “Contingent Deferred Sales Charge (CDSC)

SEBI has banned entry loads. So, the Sale Price needs to be the same as NAV. Exit loads / CDSC in excess of 1% of the redemption proceeds have to be credited back to the scheme immediately i.e. they are not available for the AMC to bear selling expenses. Exit load structure needs to be the same for all unit holders representing a portfolio.

Initial issue expenses need to be met by the AMC. There are limits to the recurring expenses that can be charged to the scheme. These are linked to the nature of the scheme and its net assets.

Dividends can be paid out of distributable reserves. SEBI has prescribed a conservative approach to its calculation.

NAV is to be calculated upto 4 decimal places in the case of index funds, liquid funds and other debt funds. NAV for equity and balanced funds is to be calculated upto at least 2 decimal places.

Investors can hold their units even in a fraction of 1 unit. However, current stock exchange trading systems may restrict transacting on the exchange to whole units.

Detailed norms on valuation of debt and equity securities determine the valuation of the portfolio, and therefore the NAV of every scheme.

Mutual funds are exempt from tax. However, Securities Transaction Tax (STT) is applicable on investments in equity and equity mutual fund schemes. Additional tax on income distributed (Dividend distribution tax) is applicable on dividends paid by debt mutual fund schemes.

Taxability of capital gains, and treatment of capital losses is different between equity and debt schemes, and also between short term and long term. Upto 1 year investment holding is treated as short term.

There is no Tax Deducted at Source (TDS) on dividend payments or re-purchase payments to resident investors. Withholding tax is applicable for some non-resident investors.

Setting of capital losses against capital gains and other income is subject to limitations to prevent tax avoidance.

Investment in mutual fund units is exempt from Wealth Tax.

Net Asset Value (NAV):

NAV = Net assets of the scheme / No. of units outstanding

= [(market value of investments + Receivables + Other Accrued Income + Other Assets – Accrued Expenses – Other payables – Other Liabilities)] / No. of units outstanding on valuation date

  • The maximum limit on the expense that can be charged to an equity mutual funds are:
    • For net assets up to Rs.100 Crore:-2.5%
    • For the next Rs.300 Crore of net assets:-2.25%
    • For the next Rs.300 Crore of net assets:-2%
    • For the remaining net assets:-1.75%
    • These limits are lower by 0.25% for debt funds
  • These regulatory ceilings are applied on the weekly average net assets of the mutual fund scheme.
  • The investment management fees are regulated by SEBI as follows:
    • For the first Rs.100 crore of net assets:-1.25%
    • For net assets exceeding Rs.100 crore:-1.00%
  • Valuation of equity shares is done on basis of traded price; provided that price is not more than 30 days old.
  • Illiquid securities can not be more than 15% of the portfolio’s net assets. Any illiquid assets above this limit have to be valued at zero.
  • Thinly Traded Equity / Equity Related Securities: Equity / equity related instruments are thinly traded if:
    • Monthly trading value is less than Rs. 5 lacs and value less than 50,000 share volume.
    • When trading is suspended up to 30 days take the last traded price.
    • Trading is suspended for more than 30 days AMC/Trustee to make valuation
    • Thinly Traded Debt Securities: Traded value (other than g-sec) is less than Rs. 15 crore for a period of 30 days prior to valuation date.
    • Non-Traded Securities: When not traded on any Stock Exchange for 30 days prior to valuation date.
    • Non-traded/thinly traded securities shall be valued “in good faith” by AMC

The following expenses cannot be charged to the scheme:

  • Penalties and fines
  • Interest on delayed payment to unit holders
  • Expenses which is not related with schemes
  • Expenses on investment management
  • Expenses on general administration, corporate advertising and infrastructure costs
  • Software development cost
  • Other costs which are prohibited by SEBI

Tax Structure in Mutual Fund:

  • Mutual funds themselves pay no tax on the incomes they earn. They are fully exempt from tax.
  • If an investor holds units for 12 months or less, any gain from selling the units is called as short-term capital gain
  • Short-term capital gains are taxable at the marginal rate of taxation of the investor
  • If an investor’s holding period is more than 12 months, any gain or loss from sale is called as long-term capital gain.
  • Long-term capital gain can be indexed for inflation
  • Indexing refers to the updating of the purchase price, based on the cost of inflation index published by CBDT. The formula for indexation is purchase price X (index in the year of sale/index in the year of purchase)
  • Investors can pay either 10% tax (plus surcharge) on the capital gain tax without indexation or 20% tax (plus surcharge) on capital gains after indexation, which ever is lower.


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