Liquid Money Guide for CORPORATES, SMEs & BANKS

Sameer Rastogi
Budget 2011 increased the dividend distribution tax (DDT) for corporate investors to 30%, up from 25% a year back in case of liquid funds and up from 12.5% in case of all other debt funds. This report handles the issue of circumventing the taxation. It also highlights the alternatives to convention liquid funds for finance managers.

SAKSHAM WEALTH SOLUTIONS P. LTD. 857, 8TH FLOOR, TOWER B2, SPAZE ITECH PARK, SEC49, SOHNA ROAD, GURGAON, WWW.SAKSHAMGROUP.COM 02/04/2012

INDEX
1. 2. 3. 4. 5. 6. Why Companies invest in Liquid Funds? Who has been investing and how much? What is the current tax structure for investments in mutual funds? Are the liquid funds still a good bet for Companies? What is an Arbitrage fund? How Arbitrage is superior to Liquid Funds?

1.Why Companies invest in Liquid Funds?

2. Earn interest even for 1 day: Liquid / Income funds compute their NAVs on daily basis. Each investor is eligible for gains on daily basis. This is extremely advantageous over bank deposit who often demands a minimum period exceeding 7 days for large amount and 30 days for small amounts. Treasury departments of large corporate would often make some extra gains for their employers by parking the surplus money for weekends and holidays. 3. Higher Gains: Normally, a current account is not supposed to yield you any interest rate. Also, if you wish to strike a deal with your banker for 7 days term deposit to 30 days term deposit, the interest rates offered are substantially low and often match with Savings Account interest rates. However, Liquid Funds would always score over Banks. The rate of interest were always much higher than CASA (Current and Savings Account) and sometime would match the fixed deposit rates. 4. Low Taxation: For any investment period of less than 1 year, Companies would park their capital in Dividend Reinvestment option of liquid funds. We know that Dividends are tax free in the hands of investor. However, an indirect tax called Dividend Direct Tax is applicable on Dividends distributed or reinvested. DDT, as it is popularly called, has been rising from being ZERO several years back to nearly 30% now for Corporates, Banks and other businesses.

2. Who has been investing and how much?

The table below shows the amount of funds invested in several categories of mutual funds. Corporates and HNIs are extremely active in DEBT / Liquid fund category. The statistics are sourced from AMFI (Association of Mutual Funds of India) website.

3. What is the tax structure for investments in

mutual funds for FY 2012-13?
The Tax Reckoner below shows that Companies are being taxed in the most harsh manner.

4. Are the liquid funds still a good bet for Companies?

Despite of high DDT, the lure of Liquid Fund has remained upbeat. This was mainly on account of convenience and flexibility of liquid funds. The flow of money into Liquid Funds has been high in last 2 quarters of FY 201112. Following are the reasons: 1. Liquid Funds quickly adjust to change of interest rates in the market: As the short term interest rates have moved up in last 1 year, liquid funds could give immediate reward to the investors. Whereas Banks, driven by managerial bottlenecks, were slow to respond and pass on the benefit to investors. 2. Investors could invest for 1 day as well: Flexibility of investing for uncertain period remains one of the biggest draw of Liquid / Income schemes. Investors would intend to invest for very short period but would stay longer as they discover that the contingency is delayed. 3. Current Account doesnt yield anything: The fact that funds in Banks Current Account yields a ZERO, all wise finance managers proactively park their companies funds in liquid funds. This creates extra gains out of surplus funds with ZERO TAX LIABILITY. Provided below are some of the best performing liquid funds

Scheme Performance 31/03/2012 Scheme Religare - Short Term Plan Ret (G) Sundaram - Select Debt ST Asset (App) Escorts - ST Debt (G) JM - STF (G) JPMorgan - India Short Term Income Fund (G) Birla SL - Ultra STF Ret (G) Templeton - India ST Income Plan (G) DWS - Short Maturity Fund (B) Axis - Short Term Fund Inst (G) HDFC - High Interest STP (G) 30 Day 9.18 10.34 10.22 10.71 9.98 9.98 9.42 10.08 10.81 10.21 3 Mon 9.98 10.59 8.48 10.54 8.72 9.94 9.13 8.8 9 7.91 6 Mon 11.58 10.4 9.73 10.36 9.23 9.77 9.08 8.8 9.25 9.06 1 Yr 11.84 11.31 10.29 10.09 9.65 9.6 9.48 9.26 9.25 9.22

5.

What is an Arbitrage fund?

In February 2009, The Economic Times reported that ARBITRAGE FUNDS perform marginally better than liquid funds. Neither the statistics nor us agree with the report. However, Arbitrage Funds are still a very attractive space for Corporate investors and is yet to be explored by most of the investors. Arbitrage funds typically draw mileage from the momentary mispricing between stocks, in the cash and derivatives markets, and are essentially marketneutral. Their return potential therefore, is a function of the frequency and profit margins of the arbitrage opportunities that present themselves. Returns and Risk are similar to Liquid / Debt Funds: While arbitrage funds are particularly suitable in volatile markets, their returns are always in the green as they lock in on profits while executing trades. That means, while they may or may not manage high gains on their bets, they cannot get in to losses. During the course of searching for arbitrage opportunities, their money stay invested in liquid funds or similar opportunities. Hence, ARBITRAGE funds are similar to liquid or income funds on the parameter of volatility. Taxation is similar to Equity Funds: Arbitrage funds are taxed as Equity Funds or Stocks. Here is a comparison on how Equity, Arbitrage and Debt funds are being taxed for Corporate investors.

MF Taxation for Corporate Investors

Type of Funds Equity Debt / Liquid Arbitrage Type of GAINS & Tax Rate Short Term Capital Gains 15% 30% 15% Long Term Capital Gains TAX FREE 10% ( with indexation @ 20%) TAX FREE Dividend Distribution Tax TAX FREE 30% TAX FREE

Hence, its clear from the table above that ARBITRAGE Funds offer huge tax advantage while maintaining safety of Liquid / Debt funds for Corporate investors.

6.

How Arbitrage is superior to Liquid Funds?

On the previous page, we have seen the tax advantages offered by Arbitrage Funds. Lets understand this better with the help of an illustration. Its a comparison between a liquid fund and an arbitrage fund from the same fund house (Kotak Mutual Fund).

Performance as on 31/03/2012
Kotak Equity Arbitrage Fund (Growth) Kotak Equity Arbitrage Fund (Monthly Dividend) Post Tax Outperformance by Arbitrage Fund

Kotak Liquid Kotak Liquid Fund Fund (Weekly (Growth) Dividend)

Period of Investment 30 days 60 days 90 days 6 months 1 year

8.05% 9.36% 9.35% 9.41% 9.15%

5.72% 6.88% 6.87% 6.88% 6.63%

8.87% 11.66% 11.16% 9.19% 8.43%

8.87% 11.66% 11.16% 9.19% 8.43%

55.1% 69.5% 62.4% 33.6% 27.1%

In the above matrix, Dividend options indicate TAX FREE returns earned by the investor during the respective period. Although, KOTAK Liquid has earned higher return over 6 months and 1 year period, the Arbitrage Fund has beaten it substantially on the basis of TAX FREE returns. Also, wherever the fund manager of Arbitrage fund got arbitrage opportunities, he has been able to raise the return as can be seen in 30 days, 60 days and 90 days. To sum up, Arbitrage Funds are a fantastic alternative for Finance Managers to park their companys surplus money. Arbitrage Funds are: 1. SAFE 2. LIQUID 3. TAX FRIENDLY

End of REPORT