Finance minister P. Chidambaram has clarified that equity mutual funds (MFs) are also subject to the transaction tax introduced in the Union Budget of 2004-05. They will, of course, be eligible for the waiver on long-term capital gains tax announced alongside. As for short-term capital gains tax, it will apply at a flat rate of 10 per cent.

What does the new tax structure mean for mutual fund investors?

The MF industry does not seem to be in the least displeased. According to Ravi Mehrotra, President, India, Franklin Templeton, "The extension of the revised capital gains structure to units of equity-oriented mutual fund is a positive step, and will help in sustaining and promoting the advantages of investing in the stockmarkets through mutual funds, especially among retail investors." If that sounds a little too optimistic, listen to what Ved Prakash Chaturvedi, CEO of Tata Mutual Fund, has to say. "These measures have encouraged retail investors to look at equity as a good tax-free investment class," he enthuses, "As a vibrant equity market is possible only on the back of long-term domestic individual investors, this move will also help in the revival of capital markets."

Double Whammy

But don't pop the champagne just yet. Your overall cost of owning equity mutual fund units is likely to go up. How is that? Pin it down to a double whammy. Unlike direct equity investors, MF investors end up paying tax twice. First, when they actually purchase or sell the very MF units. For example, assume that you are buying an MF scheme listed on the stock exchange. This act amounts to a taxable transaction. So here, you have to pay a transaction tax of 7.5 basis points (plus 2 per cent education cess, don't forget) in addition to the regular brokerage. And you also have to pay 7.5 basis points when you sell the same in the market. That's how the '15 basis points' tax operates: by taking half from the buyer and half from the seller.

That's not all. Once you own the units, your MF will pay the tax on any transaction made, either buying or selling shares in the market. In terms of incidence, it is the MF that must pay; but the expense will eventually be deducted from your units' Net Asset Value (NAV). In that sense, you the MF investor end up paying twice.

Things are not that clear when it comes to open ended MF schemes. This is because there is confusion over whether MFs will be treated as a 'seller' when you put money in them, and a 'buyer' when you redeem your investment. If so, these qualify as taxable transactions, and will therefore attract the 7.5 basis points tax as well. If this is indeed the case, then be assured that open ended MFs will pass on this cost also to you by way of expenses. There is still some ambiguity on this issue, according to Krishnamurthy Vijayan, CEO of JM Mutual Fund. Clarifications are currently being sought.

The Relief

So, both dealing in MFs and the dealings of MFs are taxable. But fund managers are still not sounding very oppressed with the new tax structure.

How come? "While we are awaiting the final details with regard to the applicability of the Securities Transaction Tax for mutual fund units," explains Franklin Templeton's Mehrotra, "we do not think it would have a significant bearing on the cost to investors, given the savings on capital gains tax they would now be benefiting from."

Net net, goes the argument, it could work out for the better. Fund managers, for example, might be encouraged to make fewer trades, churn their portfolios less frequently, and take up positions for longer time spans. This, in turn, could potentially induce investments that are better researched and less speculative (that bank less on short-term price volatility to make their buck, that is). Yet, the end of long-term capital gains tax could encourage flexibility in fund allocation over a span of a year or more. The message seems to be: go ahead, transform your portfolio, but don't get into rapid juggling of stocks unless your gains clearly outweigh the additional taxes.

Other Funds, Other Strategies

Debt funds have escaped the transactions tax altogether, because the underlying investments (debt securities) have been let off. The tricky question, though, concerns such hybrid schemes as balanced funds. What happens to investors in these? Well, balanced MF with an equity component of more than half will be taxed as equity MFs while others will be treated as debt funds. That's for the tax applicable to you, specifically, as a buyer or seller of these. For the actual operations of these funds, only equity deals will bear the tax, as in the case of other MFs.

Given all the changes, what should your MF investment strategy be?

First of all, it's important to recognise that 7.5 basis points is only a tiny fraction (100 'basis points' make up a percentage point), so this tax cannot be quantitatively compared easily with any other kind. Do not be daunted by it. In fact, it should not alter any investment plan that is well grounded in the hope of reasonable returns, since these returns should be many multiples more than the tax payable.

In practical terms, you should use this opportunity to generate more capital gains and less dividends by shifting your investments from dividend options to growth options.

Beyond that, within your risk profile, try shifting assets to the equity MFs umbrella. Merging your separate equity and debt fund schemes into a balanced fund can do this. Even if you want a low equity component, placing around 50 per cent in debt funds and the rest in balanced funds can easily attain this. You needn't lose sleep over the transaction tax.

India's Oil Slick

Is India's oil sector still a worthy investment for retail investors?

By Shilpa Nayak

Oil is a bewildering sector for the savviest of investors worldwide, with 'state control' being the operative phrase almost everywhere. In other words, the normal rules of free market investing do not apply. But the money is big, very big, which makes the sector irresistible. In India, the government was supposed to be ceding control, in phases, to the market. But India's oil PSUs are presenting quite a patchy picture at the moment. Their privatisation has been knocked off the agenda by the new regime, and their pricing autonomy remains constrained by a stability plan. Is it worth having money in these stocks?

India's oil PSUs, going by recent policy announcements, do have some measure of pricing freedom. The fuel price is to be benchmarked by the mean of two average prices: one, the last three months' rolling average price, and two, last year's rolling average. If global prices rise or fall, oil marketing companies are entitled to adjust their retail prices in India accordingly-but only within a price band of a maximum 10 per cent above or below the benchmark, and that too, only on a bi-monthly basis. In effect, the government has set a band within which the companies can wriggle.

In line with the policy, the latest revision took place on July 31, with petrol rising by Rs 1.10 per litre. This shores up the margins of IOC, HPCL, and BPCL, and helps cushion the effect of subsidies borne on LPG and kerosene. But if global oil prices were to soar, they would be in a spot. So that's the risk.

"Earlier when oil prices moved up, the retail price was adjusted accordingly," says Ambareesh Baliga, Vice-President, Karvy Stock Broking, adding that investors had been losing interest in oil psus post-elections. Their share prices fell sharply (by about 45 per cent), as fears persist of their having to bear the burden of public policy subsidies. Baliga, however, further adds that the new fuel-pricing policy has resulted in a reassessment of sorts. "The macro picture is much better than before," he says. And the stocks are relatively cheap at the moment. "HPCL, for example, was quoting at Rs 450 six months back, and is now available around Rs 300, which is an attractive price for this oil major." Similar is the case with BPCL (now quoting at Rs 343, down from around Rs 500 four months back) and IOC (Rs 415, from Rs 564 four months back).

Yet, the new price band will still drain the PSUs if global oil prices remain as high as they currently are: over $43 per barrel. If you expect oil prices to stay under the $40-level, by and large, the stocks look attractive. But remember, betting on future oil prices is the biggest game in global investing-with so many variables that everything else looks simple in contrast. Ensure that you are well acquainted with them.