Arbitrage Funds: Safe and Tax Efficient

Written on Monday, October 5, 2015
By Vishwajeet Parashar- Senior VP & Group Head - Marketing, Bajaj Capital Ltd.

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<p> Arbitrage funds are a category of mutual funds quite similar to liquid funds or pure debt funds where returns range is 6-9 percent per annum but when it comes to taxation they are treated like equity mutual funds. Arbitrage in financial terminology simply means- simultaneous purchase and sale of an asset in order to profit from a difference in the price. After the new tax budget, the taxation on debt funds went under some modification and have become slightly unattractive compared to the past. This move has proved somehow beneficial for arbitrage funds as investors find it more attractive from the taxation perspective.</p> <p> &nbsp;</p> <p> <strong>Let me explain the functioning with an interesting example -</strong></p> <p> &nbsp;</p> <p> At your workplace one of your colleagues is interested in buying a used ipad and he is ready to shell out 10000 for the same. Now someone known to you is selling his ipad for 7500. So in order to earn some profit you will buy it for Rs 7500 and then sell it to your colleague for 10000, making a pure profit of Rs 2500. As you are able to buy and sell at the same time. So, there is no risk, because instantly you are locking the profits and this is how arbitrage fund works. These funds explore the arbitrage prospects where the same stock is quoting at two different prices at BSE and NSE at the same time and they buy and sell in different markets and make the profits.</p> <p> &nbsp;</p> <p> <strong>Taxation</strong></p> <p> Taxation proves to be the biggest plus point with this category of funds. When it comes to taxation these funds are treated similar to the equity mutual funds and any return which you will earn after holding it for a period of 12 months will be tax free. But in case your holding period is less than 12 months then short term capital gain tax is applicable at 15 percent. So in terms of return they are very similar to liquid funds with a potential return of 6-9% based on the time frame and the returns from the instruments they have invested in.</p> <p> &nbsp;</p> <p> <strong>Better than FD</strong></p> <p> Now there might be some argument as you would compare the returns to bank FDs. Fixed deposits have a similar interest pattern but if you invest in FD and you are in 30% bracket, you will have to pay tax at the rate of 30 percent and in case you have to withdraw it before maturity then you are liable for some penalty too. Arbitrage funds is definitely better alternative, because they offer decent returns, high liquidity, lower tax and no tax if held for more than 12 months.</p> <p> &nbsp;</p> <p> <strong>Things to watch for</strong></p> <p> You need to understand that arbitrage prospects must exist for arbitrage funds to perform better. If the markets are uncertain, then good opportunities will exist for arbitrage funds and they will give decent profits, but if markets are stable enough, it might happen that the returns from arbitrage funds are unattractive.</p>

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