Taxation of winding-up proceeds
Also written Winding up of mutual funds taxation · Tax on mutual fund winding up · Winding-up proceeds
Money a unit-holder receives when a mutual fund scheme is wound up is treated like a normal redemption amount - so the ordinary capital gains rules for that scheme apply to it.
In plain language
A mutual fund scheme can come to an end. A close-ended scheme runs out its term. An open-ended one can be shut down for other reasons.
When that happens the trustees sell everything, pay what the scheme owes, and hand the balance to the unit-holders in proportion to their units.
So the investor gets money back without ever placing a redemption request.
The tax question is whether that changes anything. It does not.
The workbook's rule is one line. When the amount is received on winding up of the mutual fund, it will be treated like a normal redemption amount.
So the same holding period test, the same rates and the same fund category apply as if the investor had redeemed the units himself.
How it works
When a scheme is wound up. Under the SEBI (Mutual Funds) Regulations, 1996, a close-ended scheme shall be wound up on the expiry of the duration fixed in the scheme, on the redemption of the units, unless it is rolled over for a further period. In any other case, a scheme may be wound up, after repaying the amount due to unit-holders:
- on the happening of any event which, in the opinion of the trustees, requires the scheme to be wound up; or
- if seventy-five per cent of the unit-holders of a scheme pass a resolution that the scheme be wound up; or
- if the Board so directs in the interest of the unit-holders.
Notice. The trustees give notice disclosing the circumstances leading to the winding up (a) to the Board, and (b) in two daily newspapers having circulation all over India, and in a vernacular newspaper circulating at the place where the mutual fund is formed.
What stops on publication. From the date of publication, the trustee or the AMC shall cease to carry on any business activities in respect of the scheme, cease to create or cancel units, and cease to issue or redeem units.
The procedure.
| Step | What happens |
|---|---|
| 1 | The trustee calls a meeting of the unitholders to approve by simple majority and authorise the trustees or another person to take steps for winding up |
| 2(a) | The assets of the scheme are disposed of in the best interest of the unit-holders |
| 2(b) | The sale proceeds are used first to discharge liabilities due and payable, then appropriate provision is made for the expenses connected with the winding up, and the balance is paid to unit-holders in proportion to their respective interest in the assets as on the date the decision for winding up was taken |
| 3 | On completion, the trustee forwards a report on the winding up to SEBI and to the unit-holders |
After receiving the report, if SEBI is satisfied that all measures have been complied with, the scheme shall cease to exist. The units are then delisted from a recognised stock exchange as per SEBI guidelines.
The tax treatment. The amount received on winding up is treated like a normal redemption amount. So everything turns on which category the scheme fell into and how long the investor held the units - equity oriented fund, specified mutual fund or other mutual funds - exactly as on a voluntary redemption.
One thing the workbook does not say. It does not treat a winding up as a transaction outside the definition of transfer, the way section 13.6 does for stock lending or section 13.9 does for a scheme consolidation. There is no exemption here; the winding-up payout is simply a redemption.
A worked example
Illustrative figures, applying the workbook's own rule and rates.
Mr Iyengar holds 20,000 units of a debt-oriented scheme, bought on 10 February 2023 at Rs 25 a unit, so Rs 5,00,000 of cost. The scheme is wound up and he receives Rs 6,40,000 on 12 March 2025.
He placed no redemption request. The money simply arrived.
| Step | Position |
|---|---|
| Nature of the receipt | Treated like a normal redemption amount |
| Units acquired | 10 February 2023, so before 1 April 2023 |
| Section 50AA applicable? | No, because the units predate the cut-off |
| Holding period | Over 2 years, so long-term |
| Capital gain | Rs 6,40,000 - Rs 5,00,000 = Rs 1,40,000 |
| Tax at 12.50% | Rs 17,500 |
Now change the purchase date to 10 June 2023. The units are then acquired on or after 1 April 2023, the scheme is a specified mutual fund, and section 50AA deems the gain short-term irrespective of the holding period.
| Bought 10-02-2023 | Bought 10-06-2023 | |
|---|---|---|
| Nature of gain | Long-term | Short-term, by section 50AA |
| Rate | 12.50% | Slab rate, say 30% |
| Tax on the same Rs 1,40,000 | Rs 17,500 | Rs 42,000 |
The winding up changed nothing in that comparison. What decided the tax was the category of the scheme and the purchase date, because a winding-up payout is taxed as a redemption.
And the amount itself. Suppose the scheme's assets realised Rs 9,60,00,000, liabilities due and payable were Rs 40,00,000 and provision for winding-up expenses was Rs 20,00,000. The Rs 9,00,00,000 balance is what gets divided among unit-holders in proportion to their interest as on the date the winding-up decision was taken - not as on the date the money is actually paid out.
Why NISM asks about it
Chapter 13 (Tax provisions for Special Cases), section 13.10, Taxation in case of winding up of Mutual Funds, gives the SEBI (Mutual Funds) Regulations, 1996 grounds for winding up, the notice requirements, what ceases on publication, the procedure and manner of winding up, and the one-line tax rule that the amount received is treated like a normal redemption. Expect a question on the 75% unit-holder resolution, on the simple majority needed to approve the procedure, or on whether a winding-up receipt is taxable - it is, as a redemption.
Common exam traps
- Two different voting thresholds, in the same section. 75% of unit-holders passing a resolution is one of the three grounds on which a scheme may be wound up. A simple majority at a unit-holders' meeting is what approves and authorises the winding-up procedure. Do not answer one with the other.
- A winding-up receipt is not exempt. It is treated like a normal redemption, so the ordinary capital gains rules and rates apply.
- The proportion is fixed as on the date the decision was taken, not the date of payment.
- Liabilities and winding-up expenses come out first. Unit-holders take the balance, not the gross sale proceeds.
- A close-ended scheme winds up automatically at the end of its fixed duration, unless rolled over. The three grounds in the workbook are for any other case.
- Notice goes to SEBI and to newspapers, before the unit-holders vote. Once the notice is published the AMC cannot create, cancel, issue or redeem units.
- This is not a scheme consolidation and not a segregated portfolio. Section 13.9 makes a consolidation not a transfer; section 13.10 gives no such relief for a winding up.
Where this is taught
Free preparation for NISM Series X-BRelated terms
- Consolidating and consolidated schemeThe mutual fund merger pair — the consolidating scheme is merged away, the consolidated scheme is merged into — where the exchange of units is not treated as a transfer for tax.
- Other Mutual FundsThe residual, fourth category in the post-2023 mutual fund tax classification: funds that are neither equity-oriented nor a Specified Mutual Fund, taxed under the ordinary period-of-holding rules.
- Segregated portfolio cost formulaThe rule for splitting a mutual fund unit's original cost of acquisition between the main scheme and a segregated portfolio, in the same proportion as the fall in each portfolio's net asset value.
- Specified Mutual FundA mutual fund caught by section 50AA — gains on it are short-term no matter how long it was held, and are taxed at the investor's slab rate.
- Equity-oriented fundA fund that puts at least 65% of its proceeds into listed domestic equity shares — the tax definition that unlocks the 12.5% long-term rate and the Rs 1,25,000 annual exemption.
- Winding up waterfallThe order in which a wound-up scheme's sale proceeds are used: liabilities due and payable first, then a provision for winding-up expenses, and only the balance to unit-holders.