'King should collect taxes like bees... taxes on Equity Arbitrage Fund perfect example': Kotak MF's Nilesh Shah

The taxation framework governing equity arbitrage funds has come back into focus after fresh industry analysis showed that a substantial share of investor returns ultimately flows to the government through taxes and transaction-related levies. Market participants say the structure reflects a form of “gentle taxation,” where steady revenues are generated for the exchequer without discouraging investor participation in relatively low-risk market strategies.

Using the Kotak Equity Arbitrage Fund (KEAF) Regular Plan as an illustration, Nilesh Shah highlighted how arbitrage funds, despite delivering modest returns, contribute disproportionately to public revenues. In FY25, the fund delivered a post-expense return of 7.50%. On this return, investors were subject to short-term capital gains (STCG) tax of about 23.92%, including cess and surcharge applicable for the year.

Quoting Aacharya Vishnu Gupta (Chanakya), Shah drew a parallel with classical economic thought. “The King should collect taxes like bees collect honey from flowers,” he said, adding, “The government laughs all the way to the bank as it collects gross revenue of 78% and net revenue of 51% from arbitrage fund returns. Aacharya Vishnu Gupta will be very happy to see that his advice is followed in the taxation of arbitrage funds.” The remark underscored how a significant portion of returns is channelled to the exchequer without disrupting investor behaviour.

Beyond capital gains tax, arbitrage activity generates additional income for the government and regulators through a range of transaction-related levies. These include stamp duty on broker contract notes, SEBI charges, transaction taxes, GST on SEBI and transaction taxes, GST on brokerage, Securities Transaction Tax (STT), and stamp duty on subscriptions to KEAF.

According to Shah, these charges totalled ₹1,050 crore in FY25, against an average assets under management (AUM) of ₹52,440 crore. This works out to roughly 2% of average AUM, or about 27% of the fund’s post-expense returns.

When capital gains tax and transaction-related charges are combined, total government revenue from KEAF is estimated at around 51% of the net return earned by investors in FY25.

Shah noted: “Total revenue (tax plus transaction charges) to the government as a percentage of net return is approximately 51%,” making the distribution of returns between investors and the state a focal point for industry discussion.

The effective burden increases further when transaction costs incurred by counterparties on the other side of arbitrage trades are considered. Shah pointed out that these costs are broadly similar in magnitude to those borne by the fund itself. Factoring them in raises the government’s overall share—through taxes and charges—to an estimated 78% of the net return generated in FY25.

A longer-term perspective shows that this outcome is not unique to a single year. Between FY22 and FY25, even when STCG tax rates were lower at 17.94% in FY23 and FY24, total government collections from KEAF—including transaction charges—averaged about 48% of net returns. Including counterparty transaction costs lifts this figure to nearly 75%.

Kotak Equity Arbitrage Fund: Returns

The Kotak Equity Arbitrage Fund has delivered stable, low-volatility returns across short- and medium-term horizons, reinforcing its role as a cash-plus alternative rather than a long-term wealth creation product. Over one month, returns remain modest and stable, closely tracking money market conditions. Over six months, returns typically annualise at 6–7%, supported by steady futures–cash spreads. As of December 2025, the fund delivered a one-year return of about 6.1%. Three- and five-year annualised returns have remained near the 6–7% range, underscoring consistency, tax efficiency and suitability for higher tax-bracket investors seeking alternatives to traditional fixed-income products.