Budget Expectations: Mutual Funds

27 Jan 2022 , 10:59 AM

As of the close of December 2021, the AUM (assets under management) of India mutual funds stands at approximately $500 billion. Normally, the mutual fund industry is said to acquire momentum once the AUM crosses $1 trillion, but that is still some time away. What is material is the frenetic growth in the last few years.

Today there are more than 11 crore mutual fund folios of which nearly 5 crore folios come purely through SIPs. On a consistent basis, the SIPs are collecting more than Rs11,000cr per month. India’s mutual fund AUM is currently 19% of GDP and about 14% of the BSE market cap. It is this growth and the sharply higher retail participation that makes it necessary to push through key changes.

Here are key mutual fund expectations from Budget 2022-23

Bring about parity between tax on debt funds and bonds

Currently, non-equity funds that invest more than 65% in debt instruments are classified as debt funds. However, the definition of long term for debt funds is a holding period of 36 months. In contrast, the definition of long term in case of listed bonds, debentures and government securities is 12 months. One of the primary budget expectations is to being parity between LTCG definition of debt instruments and debt funds.

Bring parity between tax treatment of equity funds and ULIPs

Effective April 2018, all equity funds are taxed at a flat rate of 10% on long term capital gains, held for more than 1 year. This will be subject to a basic equity exemption limit of Rs1 lakh per fiscal year. However, any partial withdrawal, premature withdrawal or final withdrawal of ULPs is free of tax. AMFI has reiterated that ULIPs remain essentially investment products, although they have been sold as insurance.

Exempt switching within same fund from purview of capital gains

This is an anomaly in mutual fund taxation that has not been resolved for a very long time. Currently, if you switch from a dividend plan to a growth scheme or vice versa, it is treated as capital transfer and subjected to capital gains tax. Similarly, when you switch from the regular plan to direct plan of the same fund, such inter-scheme transfers are again classified as capital transfers. It is expected that that the Union Budget will remove this taxation anomaly for inter-scheme transfers.

Enhancing the threshold for TDS deduction on mutual fund dividends

Since mutual fund dividends became taxable from April 2019 due to scrapping of DDT, the Income Tax department has stipulated tax deduction at source (TDS) in case the income distribution is more than Rs5,000 per financial year. Investors feel this limit is too low and needs to be enhanced to Rs50,000 per year. More so, since the current exemption limit on bank FD interest for TDS has been raised from Rs10,000 to Rs40,000. This would reduce the hassles for investors to file returns and then wait for the refund.

Extend Section 80C to DLSS funds too

Currently, there is Section 80C exemption available on investments in Equity Linked Savings Schemes (ELSS) funds. This is subject to the outer limit of Rs150,000 blanket limit. However, this ELSS has to mandatorily be an equity oriented fund. It is expected that Budget 2022-23 will also extend this facility to debt funds and create a separate DLSS category within debt funds. Investments in these funds would also entitle the investors to claim tax benefits under Section 80C, albeit with a 3-year mandatory lock-in. This will come as a boon for conservative investors too.

Time to extend Section 54EC to mutual fund for LTCG benefits

Between 1996 and 2000, there was Section 54EA and Section 54EB wherein long term, capital gains on other assets could be reinvested in mutual funds with lock-in periods of 3 years and 7 yeas respectively. However, in Budget 2001, these two sections were replaced by Section 54EC, but it only gave this exemption benefit to infrastructure bonds issued by REC and NHAI. It is proposed that in the Budget 2022-23, these benefits of Section 54EC can be also extended to mutual funds having a portfolio that is predominantly invested in infrastructure assets. Also, the 3-year lock-in period can be continued.

Rationalization of LTCG classification of ETFs and FOFs

In the last few months, passive investment avenues like ETFs and Fund of Funds (FOF) have attracted a lot of buying interest. However, the tax rules are still not favourable. For instance, debt ETFs and gold ETFs are still treated as non-equity assets and it is time to reclassify their LTCG definition at 1 year instead of 3 years. Also, in the case of FOFs, even equity FOFs are classified as non-equity funds. This anomaly needs to be corrected in this Union Budget.

Adopting global best practices on fund management outsourcing

The global practice is for insurance companies to focus on managing risk and originating products while the investment management is outsourced to professional mutual funds. That is not permitted in the current regulations. The SEBI Act and the IRDA rules need to be tweaked but this would reduce the hassles for insurance companies and open up a new avenue for mutual funds to expand their franchise. This could go a long way.