Mutual funds have emerged as key investment intermediaries in the Indian capital markets. In the last 5 years, assets under management (AUM) of mutual funds tripled from Rs.8 trillion to Rs.25 trillion. The SIPs are flowing in almost to the tune of $1.2 billion (Rs.8020 crore) per month and there are more than 2.50 crore SIP accounts that are active. We are not even talking about the number of folios which can be quite misleading. The moral of the story is mutual funds are here to stay as an integral part of the Indian capital markets. Let us look at what mutual funds are expecting from the Union Budget?
Reduce or eliminate the LTCG tax on equity funds
The exemption on long term capital gains has been one of the major attractions of equity mutual funds. The LTCG tax, therefore, has come as a major negative for long term planning using mutual funds. It may be recollected that in the 2018 Budget the government imposed 10% LTCG tax (above Rs.1 lakh per year) on equities and on equity funds too. This is a big negative for investors who use equity funds as a tool to plan their financial future. More so, because this tax is imposed without any benefit of indexation! LTCG reduces the yield by 200 bps in the short term and by nearly 40 bps in the long term. That would mean; you either need to reduce your plan targets or increase you savings. Since STT is already payable on redemption of equity funds, LTCG can be scrapped. As an interim measure, the government can look at least reducing the rate of LTCG tax on equity funds at 5% or at least extend the benefit of indexation for equity funds.
Dividend distribution tax on equity funds is having a cascading effect
This is the latest level of cascading effect that was introduced n the 2018 budget. The DDT on equity fund dividends was introduced in the 2018 Budget. This amounts to double taxation because companies have already paid tax when they declare dividends. In addition, there are a lot of investors who depend on dividends from mutual funds as a regular source of income. This DDT actually changes the economics of dividend income. The demand has been to scrap the DDT on equity fund dividends since there is already one level of DDT that has been paid at the company level.
Promote Fund of Funds (FOFs) for financial planning
FOFs are a big industry in developed markets as a tool for financial planning and pegging assets to goals. Fund of funds (FOFs) have failed to take off in India in a big way principally because of its skewed tax treatment. For example, even if a Fund of Equity funds is created, it is still treated as non-equity investment for tax purposes. This positions the FOFs negatively from the perspective of long term and short term capital gains. This largely takes away the attraction of FOFs from a financial planning point of view. Globally, FOFs are extensively used by investors and financial planners To begin with the budget can make a start b classifying funds of equity funds as equity fund so that they can become more rampantly used in financial planning.
Restore the Section 54EF benefits on reinvestment of capital gains in MFs
The benefit of Section 54EF pertains to reinvestment of capital gains into MFs to save tax. This was permitted till 2003, after which it was scrapped. The lock-in period of 3 years can continue and this will be a big boost for mutual fund investments. All the investment restrictions and capital gains account conditions can be extended to mutual funds also. This will provide one more avenue for investors to participate in mutual funds.
Extend the benefits of ELSS incentives to debt funds too
Currently, Section 80C benefits are only available to equity ELSS. While it is true that ELSS helps combine tax benefits and wealth creation, it has a downside. It leaves out most conservative investors from its ambit. This can be overcome by extending the benefit of Section 80C to debt funds also, subject to a lock in period of 3 years. If the aim is to promote organized and systematic long term savings, then the government need not differentiate between equity and debt. This would enable conservative investors to also get the benefit of tax saving and enhance their effective returns significantly in post tax terms.