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Boost to bond funds

Aabhas Pandya/Value Research

Budget 2001-02 is bonanza for bond funds and monthly income plans with dividend tax slashed from 22 (20 per cent plus 10 per cent surcharge) to 10.2 per cent.

The budgetary sop will see the re-emergence of dividend plans as a preferred option. At the same time, it means a sharply lower tax liability for the marginal tax-payer who was burdened with a 22 per cent dividend tax last year even though he had the required limit under section 80L.

"The dividend tax is actually lower at 9.25 per cent if you take the dividend tax as part of the total outflow. It is going to give a big boost to debt fund inflows," says the Delhi-head of a mutual fund, whose mobilisation target for the next fiscal was doubled after the cut in dividend tax.

The lower dividend tax has also come as a breather for open-end monthly income plans, where a 22 per cent tax on the monthly cheque was significantly eroding returns. For instance, even though your MIP could pay you one rupee, it was forced to declare only 78 paise since the rest was being taxed by the exchequer. Now, you can expect a dividend of 90 paise.

This will be especially comforting to those investors who wanted a monthly income but were forced to choose a different option to save on tax.

Similarly, it translates into a higher assured return for investors in UTI's monthly income series. In this case the dividend for a particular year was announced after adjusting for a 22 per cent tax.

With the same now reduced to 10.2 per cent, MIP investors can expect the assured payout for 2001-02 to go up. However, the overall decline in interest rates in the economy after the rate cut on small savings would marginally bring down the assured return in future MIPs.

Besides, there are some indirect benefits for bond funds. For one, the limit under section 80L stands reduced from Rs 12000 to Rs 9000. Thus, any interest income beyond Rs 9000 will be taxed under the normal tax bracket.

At the same time, interest income beyond Rs 2500 will be subject to tax deduction at source (TDS) against the earlier ceiling of Rs 10000. Thus, your interest income on a bank fixed deposit of as low as Rs 30,000 (assuming 8.5 per cent per annum) will be subject to TDS. This makes bond funds attractive vis-à-vis bank deposits since in the former, dividend tax is only 10.2 per cent now.

The assured returns on government sponsored small saving schemes has been cut by 1-1.5 per cent. This will bring down the returns across the spectrum including bank deposits, thus making bond funds a superior investment alternative since they can supplement interest income with trading profits.

"The yields have crashed and we now expect another rate cut by the RBI. We have got more than we had expected from the budget and the outlook is bullish,'' says Rajiv Anand at ANZ Grindlays Mutual Fund.

"The government borrowing at Rs 118 lakh crore is marginally higher than last year's figure of 1.17 lakh crore. It's a big positive and overall, the going should be smooth,'' says Nilesh Shah, chief investment officer at Templeton.

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