Stock market scams, fears of war and the technology sector downturn saw the stock markets spiraling downward. This scared the retail investor away not only from the equities, but also from the equity-based schemes of mutual funds.

As a defense, the mutual fund industry discovered and began to sell debt-based instruments aggressively. I started vociferously claiming that the Pure-Growth Open-ended Debt-based schemes of mutual funds have emerged as the one and only parking place for all the investible funds of all the assessees, retail or otherwise.

Being pure-growth, these are quite tax efficient.

Instead of paying tax on normal income at the rate of 10 per cent, 20 per cent or 30 per cent, depending upon the size of the income, it is good to pay income tax at the rate of 10 per cent, which is the rate applicable to long-term capital gains.

Suppose you invest Rs 80 lakh (Rs 8 million) in a POD and at the end of one year, it grows to 86.4 lakh (8.64 million = growth rate of 8 per cent p.a.). You then decide to strip the grown by withdrawing Rs 640,000. The capital portion of this withdrawal is Rs 592,593 [= (80 / 86.4) x 640,000]. The rest -- Rs 47,407 -- will be capital gain.

The tax on this growth is Rs 4,701 (= 10 per cent of Rs 47,407).

This implies that you have got Rs 640,00 in hand, but tax thereon is only Rs 4,701. This works out at 0.73 per cent tax and not 10 per cent, as is the general impression.

Finally, if you have no other income, your total income is Rs 47,407 and this being lower than the tax threshold of Rs 50,000, you do not have to pay any tax.

Incidentally, on the same income earned by way of interest, say on Reserve Bank of India taxable Savings Bonds with 8 per cent coupon rate, the tax applicable is Rs 166,000.

Being open-ended, these behave like a savings bank account, where you can deposit and withdraw at will.

The only difference is that banks take five minutes to effect a withdrawal, while mutual funds take five working days or less.

Being debt-based, the safety of the capital as well as the income (over 12 per cent at this juncture) is implicitly certain, but not explicitly assured.

However, the Indian stock markets have started looking up -- thanks to the soft interest rates which boost the bottom line of companies, the expectations of a good monsoon, falling oil prices, excellent results posted by many companies and other factors.

Some market gurus have predicted that the market will now witness a 'record bull phase.' This could be the time to shift over to POEs (Pure-Growth Open-ended Equity-based schemes) especially those of you who have some risk appetite and believe in the adage, 'no risk, no gain.'

These schemes offer three options:

• Regular Dividend.
• Reinvestment of Dividend, and
• Growth.

Do not touch the dividend paying option. The recent Finance Act has made dividend free from tax in the hands of the investors though the companies pay dividend distribution tax at the rate of 12.8125 per cent.

But equity-based schemes have been exempted from this dividend distribution tax for the fiscal year 2003-04 only. Post that, the authorities may either continue with this benefit or make these schemes taxable like other mutual fund schemes, depending upon the situation.

Equity investments are essentially a long-term play and as such investors should not let themselves be held captive to the government's caprice. Just like collection of taxes is the right of the government, planning one's taxes for optimum benefit is the investor's privilege and he should be allowed to use it.

Therefore, investors cannot take the risk of this surrogate dividend tax being slapped on equity schemes depending upon the whim and fancy of the powers that be.

This tax does not attract any credit for the company or its shareholder. Consequently, the company cannot treat this as a part of its expenses and even the shareholder cannot treat it as TDS (tax deduction at source) for setting it off against his tax liability.

The investor is robbed of saving tax on this income by appropriate tax planning such as contribution to Section 88 (of the Income Tax Act).

Even those with income below the minimum tax threshold of Rs 50,000 have to pay this 12.8125 per cent tax indirectly.

Evidently, the exchequer will collect more tax by applying this 'tax-free dividend' ruse and also save the cost of collection and litigations. The only positive fallout of this ruse is the elimination of the huge wastage involved in issuing TDS certificates for claiming credit for the TDS.

Reinvestment plan is a cousin of the regular dividend scheme and is equally untouchable.

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