Equity arbitrage funds, a sub-category that offers 'debt like return and equity like taxation benefits', have also been hit by the new tax. The returns from equity arbitrage funds are comparable with those of short-term and ultra-short term debt funds. Investors, especially HNIs, used to park their short-term funds in these funds to gain from the tax advantage. While debt fund investors were forced to pay a dividend distribution tax of 28% (ie 25% plus 12% surcharge), there was no dividend distribution tax (DDT) here.
# 30% tax + 15% surcharge + 4% cess for upto 3 years; 20% (with indexation) + 4% cess after that. If we assume 8% returns from debt funds and 5% inflation rate, inflation adjusted tax will be only 20.8% of 3% (ie 0.624%). and on the original gain of 8%, the effective tax rate works out as 7.8%. Data as on 5 Feb 2018
Arbitrage funds make money by buying and selling in different market simultaneously to corner the price difference. Their risk profile is comparable to that of debt funds. However, these funds can be very volatile in the short term (less than three months). Since NAVs can fluctuate wildly for short holding periods, the ideal investment horizon for this segment is 6-12 months
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