SWAP – Smarter solution for regular cash flows
VP Products & Business Development
The Finance Bill, 2018# has proposed to introduce tax on Long Term Capital Gains (LTCG) on equity and equity oriented funds @ 10% (plus surcharge, as applicable and cess) for gains exceeding 1 lakh in the financial year. Further, it has also proposed introduction of Dividend Distribution Tax (DDT) @ 10% (plus surcharge, as applicable and cess) for dividends paid on equity oriented mutual funds. A closer look at the trend of inflows over the past few years highlights that investors have opted for dividend payout option to meet their monthly cash requirements. With the introduction of DDT on equity oriented funds, investing in dividend option of equity oriented mutual funds may be less tax efficient. Alternatively, investors can use the Systematic Withdrawal Advantage Plan (SWAP) to meet their monthly cash requirements in a tax efficient manner.
Systematic Withdrawal Advantage Plan (SWAP) offered by HDFC Mutual Fund enables investors to redeem a pre-defined amount from their investments at regular intervals. Unit-holders have an option to select any date of the month i.e. between 1st to 31st as SWAP withdrawal date. Currently, Fixed SWAP Plan is available for Monthly/Quarterly/Half yearly/Yearly intervals and Variable SWAP Plan is available for Quarterly/Half Yearly/Yearly intervals only. Fixed Plan is available for Growth and Dividend option whereas Variable Plan is available for Growth Option only.
In case, Fixed SWAP is opted on your holdings in growth option, in the initial period of SWAP, the gain portion is much smaller. Most of the payout actually consists of the principal (investment). Over time, the principal component of the payout decreases giving way to the gain component. The short-term capital appreciation (selling price– cost of acquisition) would be taxed at the rate of 15% (plus surcharge, as applicable and cess). As per the proposed Finance Bill, 2018#, long-term capital gain would be charged at 10% (plus surcharge, as applicable and cess) without indexation.
#The amendments proposed as per the Finance Bill, 2018 are subject to approval of both the houses of parliament and assent of President of India. Please consult your tax advisor for further details on Finance Bill, 2018 and any amendments thereto.
Illustration of SWAP in HDFC Prudence Fund
How would a Fixed SWAP in the Growth Option of HDFC Prudence Fund work?
As seen in the illustration, the rise in NAV (Column 2) leads to a lower number of units getting redeemed (Column 4) for the same transaction amount (Column 6). Since the tax has to be paid only on the realized capital gains (Column 7), the initial taxable income is very low. Additionally, after 1 year the entire investment becomes a long term asset thereby further enhancing the tax efficiency. This serves a secondary benefit, where-in the unused units appreciate further during the course of the investment thus keeping the end investment value above the original investment. Hence to summarize, as time goes on and the NAV value increases, the principal component per SWAP comes down, thereby retaining a larger portion for future capital appreciation.
SWAP in HDCF Prudence Fund – A Smart Solution for your Regular Cash Flows
Illustration: Summary of a Back Test Model (HDFC Prudence Fund)
The above table shows the impact of proposed taxation for investment in dividend option vis-a-vis SWAP in Growth option of HDFC Prudence Fund. Under dividend option, net tax outgo on dividends of Rs 6,00,000 would be Rs 68,640 and under growth option net tax outgo on withdrawal of Rs 6,00,000 would be Rs 18,579. Thus, post the proposed changes in taxation, opting for SWAP under Growth Option would be more tax efficient.
Exit Load Structure
In respect of each purchase/switch-in of units, 15% of the units (“the limit”) may be redeemed without any exit load from the date of allotment. Any redemption in excess of the limit shall be subject to the following exit load:
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