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Gains from MF switch under tax scanner
July, 22nd 2008

Indian tax authorities are putting to good use their information network to spot evasion and bolster collection.

Taxmen have now trained their sights on several investors who had invested a few lakhs in mutual fund schemes and then switched between schemes. The income-tax department is scrutinising the tax returns of several individuals, who have switched their investments during the course of a year.

The exercise is primarily aimed at preventing tax evasion and ensuring greater compliance. In several cases, the income-tax department has started examining tax returns to ascertain whether investors have short changed it by not paying short-term capital gains tax while exiting a scheme before the completion of one year. Switching schemes does not violate any norms, but investors have to pay a short-term capital gains tax of 15% if they sell the units of a mutual fund or stocks before one year.
Not just that. Many individuals, who had invested over Rs 2 lakh in some of the mutual funds, have been told to provide proof of their source of funds for such investments, an official said.

Among those whose returns were picked up by the tax officials include pensioners, who switched their mutual fund investments and filed their tax returns last fiscal. Their returns were picked up for scrutiny based on third party information given by the mutual funds to the tax department.

The tax department will seek an explanation on the source of funds used to finance these investments, even if it means that the investor has used the same corpus to invest in a particular mutual fund after exiting from another.

All mutual funds are mandated under the income-tax law to list transactions of clients who buy units worth Rs 2 lakh or more. They also need to quote the permanent account number (PAN) of these customers. So, an individual who buys units in a particular mutual fund, but exits the fund within six months to purchase units in another fund, will have two transactions in his ledger, called individual transaction statement.

This is because both the mutual fund houses independently file annual information returns (AIR) with the tax department. This information, in turn, is matched with the tax returns of the individual to check if he has assets disproportionate to his known sources of income and has short paid taxes.

According to tax department officials, the income tax returns of such individuals are likely to be picked up for scrutiny as there is no way now to check if the taxpayer is rolling his money over for various investments.

While PAN establishes an audit-trail of these transactions, there is no one-to-one linkage between every investment and the source of funds. Several taxpayers whose returns were picked up for scrutiny have informed the department that they merely rotated their money. This is more so for senior citizens who move their capital frequently. In most cases, the department has accepted their explanation and dropped proceedings against them, said a senior tax department official.

But the problem is likely to continue even in the current fiscal. Experts said a statement akin to a cash-flow would help resolve the problem. But that is out now. So taxpayers have to reconcile to the fact that their returns may be picked up for scrutiny this fiscal also and then hope to sort out their problems on a case-to-case basis.

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