You might know about Growth and Dividend option while investing in mutual fund but very few of us are aware of the “Bonus” option offered by mutual funds. In this post I have written about what bonus options of mutual funds mean and how it can be used to save taxes!
We take example of Arbitrage Mutual Fund which has Net Asset Value (NAV) of which is Rs. 20.
Below is example explaining Growth, Dividend and Bonus Option.
For Growth option the NAV would increase by 9%, so the new NAV would be Rs 21.8 and your number of units remain at 50,000. So your fund value = 21.8 X 50,000 = Rs 10,90,000
In case of dividend option the fund can give entire profits as dividend. So in this case the fund might payout Rs 1.80 per unit as dividend. At the end you would have 50,000 units of the fund with NAV as Rs 20 and additional Rs 1.80 X 50,000 = Rs 90,000 as dividend. [Here I have ignored DDT for simple calculation]
In case of bonus option, suppose the fund declares bonus ratio of 2:1, which means that for every 2 units investors would get 1 additional unit. So the investor would get additional 25,000 units.
Total units after bonus = 75,000
NAV (after bonus) = Rs 21.8 X (2/3) = Rs 14.53 [as the NAV adjusts for bonus units]
Your maturity amount = 75,000 * Rs 14.53 = Rs 10,90,000
We take the above example and show you how you can save taxes with time lines.
Purchase Amount = Rs 20 X 50,000 = Rs 10,00,000 [on April 1, 2014]
NAV just before Bonus = Rs 21.8 [on March 14, 2015; assuming 9% returns in the period]
Bonus – 1 bonus unit for every 2 units held
NAV adjusted for bonus bonus = Rs 14.53 [on March 15, 2015]
Number of total units after bonus = 50,000 + 25,000 = 75,000
After the bonus is declared you can redeem your initial 50,000 units in the fund.
Redemption Amount = Rs 14.53 X 50,000 = Rs 7,26,667 [on March 16, 2015]
As the fund is sold within one year of purchase, it would lead to Short Term Capital Loss = Rs (10,00,000 – 7,26,667) = Rs 2,73,333
This short term capital loss can be adjusted against any Short Term or Long Term capital Gains from other assets in the financial year. Additionally if you cannot offset it fully in this financial year, you can carry forward this loss to next 8 years!
Next you can sell the remaining units after 1 year of bonus declaration.
So assuming 9% annual return
As arbitrage funds are considered equity funds, long term capital gains are tax free!
The above process of taking Tax Advantage is known as Bonus Stripping and is perfectly legal.
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Good post with good details. Is bonus option a 3rd category or it comes under growth option?
It's third option in mutual funds after growth & dividend.