There is a lot of confusion about how the payout from Franklin Segregated funds (Vodafone Idea papers) will be taxed. After reading a lot about the taxation for the past 3 days, I think I finally have a good idea. If you received a payout from Franklin, you will find all the details on how to calculate your tax. I can tell you upfront that we are at a tax disadvantage. Moreover, you might have to pay advance tax depending on how much you received. In the rest of the post I will be using Franklin Ultra Short-term Bond fund as an example, but you should be able to do the same for any other fund. If you'd rather watch a video instead of reading this post, scroll to the bottom.

How to calculate capital gain

There are a couple of things you need to figure of the capital gains and thus the tax. First, you need to know the cost of capital. Second, you need to know if the investment is going to be long term capital gain or short term capital gain. The Union Budget 2020 clarified how to calculate the cost of capital and the duration of the investment.

Cost of acquisition

The finance bill says "The cost of acquisition of a unit or units in the segregated portfolio shall be the amount which bears, to the cost of acquisition of a unit or units held by the assessee in the total portfolio, the same proportion as the net asset value of the asset transferred to the segregated portfolio bears to the net asset value of the total portfolio immediately before the segregation of portfolios".

Lets take an example using Franklin Ultra Short-term fund. The AMC created a segregated portfolio on Jan 24, 2020. So to find the cost of acquisition, we need to know the NAV of the fund on date of purchase. Lets say it is Rs. 25. Next, we need to find the proportion of the segregated fund. If you look at the portfolio update released by Franklin, we come to know that the proportion is 4.2% for Franklin Ultra short-term fund. Now all we have to do is find the proportional NAV for the segregated fund.

NAV of segregated fund = 4.2 / 100 * 25 = 1.05

Proportion of segregated papers in main portfolio
Proportion of segregated papers in main portfolio

However there is a problem with this calculation, which is that the percentage of segregated fund is actually zero on Jan 23, 2020. The 4.2% was when the AMC decided to mark down the Vodafone papers to zero on Jan 16, 2020. This is the unfortunate truth about Franklin funds. The situation would have been different if the AMC did not mark them down to zero on Jan 16 and instead waited until Jan 23 when Vodafone papers were downgraded to junk bonds. Anyway the cost of acquisition for the purposes of tax is zero.

How to determine the duration of investment?

The next thing we need to determine is the duration of your investment. Again the financial bill helps us here. According to the bill "In the case of a capital asset, being a unit or units in a segregated portfolio referred to in sub-section (2AG) of section 49, there shall be included the period for which the original unit or units in the main portfolio were held by the assessee".

All your investments before segregation will continue to maintain the investment date. Investments that are more than 3 years from the date of payout, will be considered as long term. Check your investments and figure it out.

Calculation of tax

Now that you know your investment dates you can proceed to calculating your taxes. Note that since the cost of acquisition is zero, you cannot avail indexation benefits. Lets take an example. Lets say you purchased 10,000 units of Franklin Ultra short-term fund on Jan 1, 2017. Furthermore, you purchased another 10,000 units on Jan 2, 2018. The first investment is long term and the second one is short term in nature. The NAV on payout date is 1.4320.

Long term income = 1.4320 x 1000 = 14320
Short term income = 1.4320 x 1000 = 14320
Long term tax = 14320 x 20% = 2862
Short term tax = 14320 x your applicable tax rate

Because the cost of acquisition is zero, you lost all the benefits of indexation. Franklin clearly mentioned that the cost of acquisition is Nil in all it's email communication.