SEBI mandated rationalization and categorization of mutual fund schemes in October 2017.
With this rule, all the existing mutual fund schemes had to fit in one of the categories specified by SEBI. There was an additional rule of only one fund per category per AMC. This resulted in many existing MF schemes getting merged in a new scheme.
From an investor’s perspective, this is a welcome move. Such rationalization will reduce clutter and help investors make better-informed decisions.
What about the calculation of returns and capital gains?
However, after such mergers, the calculation of capital gains becomes a bit complicated at least if you want to do it on a piece of paper.
Even though you can download such information from AMC or RTA websites, it is always better to know how such calculation works. Moreover, RTA statements are throwing up strange values for results at the moment.
What is the problem?
The problem happens when NAV of the new scheme (in which many schemes have merged) is different from the NAV of the old scheme.
The change in NAV is due to the merger of other schemes (in addition to your scheme) into the new scheme i.e. your scheme is not the only scheme that has merged into the new scheme. There could be many others.
Whatever the reason be, if the NAV of the new scheme is different from NAV of your old scheme (but the portfolio value has to be same), the number of units held changes.
Let’s understand through an example.
- NAV of the old scheme (A) on the date of the merger (NAV of A on the date of the merger)
- NAV of the new scheme (B) on the date of the merger (NAV of B on the date of the merger)
- Number of units of the old scheme on the date of the merger (No. of units of A held)
- Number of units of the new scheme (No. of units of B received)
Value of your portfolio on the date of the merger
= NAV of A on the date of merger X No. of units of A held
= NAV of B on the date of merger X No. of units of B received
Effectively, the value of your portfolio does not change because of the merger or switch-in.
If the NAV of scheme A is Rs 50 and NAV of scheme B is Rs 100 on the date of the merger, you will get 1 unit of B for every 2 units of A held. This will ensure that the value of your portfolio remains the same.
If the NAV of scheme A is Rs 100 and NAV of scheme B is Rs 50 on the date of the merger, you will get 2 units of B for every unit of A held.
Let’s understand this with proper scheme names.
HDFC Balanced Fund was merged into HDFC Hybrid Equity Fund on June 1, 2018. Therefore, HDFC Balanced Fund ceased to exist after June 1, 2018. All your investments in the scheme were transferred to HDFC Hybrid Equity Fund.
Let’s look at a hypothetical example with actual NAV values. Let’s look at this transaction statement.
As you can see, the value of your portfolio remains the same even after the merger. The difference is in the number of units and the NAV.
154.425 X 922.70 = 52.914 X 2692.84
How do you calculate returns?
To be honest, nothing much changes.
You can use XIRR to calculate your returns from the scheme. XIRR takes into account cash flows (and not units or NAV). Since the merger has not resulted in any cash flow to you, you can easily ignore the two transactions on June 1, 2018. Alternatively, you can add both the transactions while calculating XIRR.
The NAV of HDFC Hybrid Equity on June 12, 2018 was 53.169.
In the example considered above, I have taken two investments in 2018 itself. Since these investments are less than a year, these can skew results a bit.
How to calculate capital gains after merger due to SEBI categorization?
Before we get down to calculations, here are a few things to note:
- The merger of schemes does not result in capital gains per se. For taxation purpose, the merger does not mean that it is a sale in the old scheme and purchase into the new scheme.
- Due to the merger, the holding period of your investment does not change. The date of investment in the old scheme will be considered to assess exit load and capital gains tax implications.
Case 1: For the units that have been purchased and sold after the date of the merger (switch-in)
You can do your calculations the way you used to. You have purchased and sold units of HDFC Hybrid Equity Fund.
For other schemes, if the purchase (and merger) happened before January 31, 2018, grandfathering provisions may also be applicable.
Case 2: For the units that were purchased before the merger
The calculations are a bit complex. Let’s understand with the help of an example.
Let’s assume you sell units of HDFC Hybrid Fund on June 12, 2018.
The NAV of the scheme on June 12, 2018 was 53.169.
No. of units of HDFC Hybrid Fund sold = Rs 20,000 / 53.169 = 376.159 units
To work out the capital gains, you need to figure out two things.
- The number of units in the old scheme (HDFC Balanced) that have been sold.
- NAV of the sold units (in the old scheme)
How do we figure out the no. of units sold in the old scheme?
376.159 units of HDFC Hybrid Equity Fund = How many units of erstwhile HDFC Balanced Fund?
For this, you need to do the following:
376.159 X NAV of HDFC Hybrid Equity Scheme on the date of the merger (i.e. June 1, 2018)
= No. of units of HDFC Balanced X NAV of HDFC Balanced on the date of the merger
No. of units of HDFC Balanced = 376.159* (52.914/154.425) =128.819 units
This means by selling 376.159 units of HDFC Hybrid Equity Fund, you have effectively sold 128.819 units of HDFC Balanced Fund.
Your work is not yet over.
You still need to figure out which 128.891 units have been sold.
As we know, mutual fund purchases and redemptions work on First-come-First-serve (FIFO) basis i.e. the units that are purchased first are sold first.
Referring back to the transaction statement, we can see that the first purchase was on July 20, 2016 and you got 207.84 units at a NAV of 120.283. That should suffice for this example.
Essentially, those units (purchased on July 20, 2016) will be sold first.
Sale price of 376.159 units of HDFC Hybrid equity or 128.819 units of HDFC Balanced = Rs 20,000
Purchase price of 128.819 units of HDFC Balanced = 128.891 * 120.283 = Rs. 15,503.86
Capital Gain = Rs 4,496.2
Once you have figured out the capital gain, you need to see how the capital gains will be taxed (short term, long term, equity, debt).
For equity fund units (purchase before January 31, 2018) and whose sale results in Long-Term Capital Gains, there is an additional issue of Grandfathering provisions (introduced in Budget 2018).
Under Grandfathering provisions, if the sale of an equity investment (purchased before January 31, 2018) results in Long-term capital gains, then any gain accrued till January 31, 2018, will be exempt from tax.
In this example, the scheme is an equity scheme and the units were purchased on July 20, 2016. Since the units were sold on June 30, 2018, the holding period is greater than 1 year and the resulting gains will be classified as long-term capital gains.
Since the purchase was in 2016, the Grandfathering provisions will also apply.
For you to calculate the capital gain in this case, you will need NAV of HDFC Balanced Fund as on January 31, 2018, too.
NAV of HDFC Balanced on January 31, 2018 = 160.410
Value of 128.819 units of HDFC Balanced on January 31, 2018 = Rs 20,675.9
Since the value of the investment on January 31, 2018, is higher than the sale price, the entire LTCG shall be exempt. Do note there shall be no long-term capital loss either. Read this post to understand why.
To sum up,
For the units that were purchased after January 31, 2018, and after merger due to SEBI categorization
Grandfathering provisions not applicable. Calculation as in Case 1.
For the units that were purchased after January 31, 2018, and before merger due to SEBI categorization
Grandfathering provisions not applicable. Calculation as in Case 2 (without grandfathering benefit for LTCG on the sale of equity investment)
For the units that were purchased on or before January 31, 2018, and before merger due to SEBI categorization
Calculation as in Case 2 (with grandfathering benefit for LTCG on the sale of equity investment)
For the units that were purchased on or before January 31, 2018, and after merger due to SEBI categorization
Calculation as in Case 1 (with grandfathering benefit for LTCG on the sale of equity investment). In this case, there will be no NAV for the old scheme on January 31, 2018. Therefore, you will have to work with NAV of the new scheme to arrive at taxable long-term capital gains (in case of equity investments).
Points to Note
- I have considered the calculations for only 1 sale transaction. I understand this can get messy if you have to account for multiple sale transactions. You will need to work out details in an excel sheet or use a software.
- To be honest, you don’t have to worry much about these calculations. These calculations (or capital gains) will be available on RTA or AMC website or even your investment platform.
- The analysis that we have done above applies to any merger of mutual fund schemes (and not just because of SEBI MF categorization)