BUDGET EXPECTATIONS : MUTUAL FUNDS

20 Jan 2023 , 08:41 AM

Typically, mutual fund demands have centred on the aspect of parity with other instruments, taxation of mutual funds at multiple levels and other administrative issues. Here are some of the key Budget demands put forth by the mutual funds.

Treat mutual funds at par with ULIPs

In the last 20 years, the unit linked issuance plans (ULIPs) have been a close competitor to the mutual funds. However, the AMFI has repeatedly underlined that ULIPs have some tax advantages over mutual funds, which needs to be addressed to bring tax parity. 

• Switching from one plan of a mutual fund scheme to another should be made free of tax, just like it is permitted in ULIPs. Currently, even a move from growth plan to dividend plan or regular plan to direct plan attracts capital gains tax. 

   

• ULIPs are fully exempt on maturity or on redemption. For instance when you redeem ULIPs after completion of 5 years, the capital gains made in the process is fully tax free. On the contrary, capital gains made in mutual funds is taxed; both on equity funds and on debt funds. Here again the budget has called for parity.

This has been a long standing demand of mutual funds since there is no structural difference between a mutual fund and ULIP and both are effectively investment products, although ULIP is sold as an insurance product.

Key demands on the ELSS front

ELSS funds are an important category of equity funds wherein investors can growth wealth and also save tax under Section 80C of the Income Tax Act. Currently, Equity Linked Savings Schemes (ELSS) are exempt under Section 80C of the Income Tax Act up to an outer limit of Rs1.50 lakhs per year. There are 4 changes that are now being demanded by the mutual funds on the ELSS front.

• ELSS investments today can be done in a minimum size of Rs500 and in multiples of Rs500. Mutual funds believe they are losing out on a lucrative market by insisting on this multiples of Rs500. Instead, the base can be maintained and the multiple condition dropped. This will open more doors at the entry level. 

   

• ELSS facility is only available to predominantly equity funds and not to debt funds. However, there are a lot of conservative investors who may want to start off with debt investing and a DLSS may appeal to such investors. The DLSS can have a similar lock-in period of 3 years.

   

• Recently, SEBI permitted passive funds of ELSS also to be launched indexed to an index. However, if a passive ELSS is launched, then the active ELSS has to be disbanded. Since, these are 2 distinct categories, the budget can explicitly allow an AMC to have an ELSS active fund plus an ELSS passive fund.

   

• Lastly, the exemption limit for ELSS must be carved separately on the lines of the special provision available for NPS schemes. This will ensure that there is a dedicated encouragement for investing in equity oriented tax saving instrument. A separate limit of Rs1 lakh can be dedicated to ELSS schemes, include passives and DLSS.

Tax exemption on capital gains on long term equity funds

It may be recollected that long term capital gains on equity and equity funds became taxable effective from April 2018. They are currently taxed at a flat rate of 10% (without indexation) after considering a base exemption of Rs1 lakh. The problem is that this forces the investor to pay capital gains tax at flat rate of 10% even if the equity funds are held for more 15 years. This is negative for long term wealth creation and for people with financial goals, this actually puts them back on the goals path. One expectation in the budget is that the government can charge tax on equity fund LTCG between 1 year and 3 years. However, if held for more than 3 years, then the LTCG can be made fully exempt. 

Give tax breaks for reinvestment of capital gains in equity funds

There were two sections prior to fiscal year 2000-01, known as Section 54EA and Section 54EB of the Income Tax Act. The capital gains on an asset was exempted from tax if the proceeds were reinvested in select mutual funds, subject to a lock in period, which could range from 3 years to 7 years. However, post the year 2000, this provision was scrapped and that benefit of reinvestment of capital gains is only available for infrastructure bonds and not for mutual funds. Union Budget 2023-24 is expected to bring back that section wherein the capital gains from any long term asset can be reinvested in mutual funds. This would ensure that mutual funds also get flows from capital gains on assets, which his not happening today. This will open up an entirely new avenue for mutual fund investments.

Expand the definition of equity funds for tax purposes

Currently, equity funds (with more than 65% exposure to equities) have a special treatment as they are classified as LTCG with a 1 year holding and are taxed at a lower rate. All other funds are classified as non-equity funds, which have to be held for minimum 3 years to qualify as long term, and even then the tax rates are higher. The budget expectation is that all risky funds like gold funds, index funds, index ETFs and REITs are treated at par with equity funds for tax purposes. This can boost their demand substantially.

Scrap STT on equity funds

There has been a persistent demand for scrapping securities transaction tax on equity fund redemption. When equity funds are redeemed, there are various costs like the exit load, the STT and the capital gains tax. This is over and above the Total Expense Ratio (TER) that fund holders have already paid. This substantially slices away the returns on an equity fund. Since STT was introduced in lieu of long term capital gains tax, it is only logical that with the LTCG tax being reintroduced, the STT is scrapped.

Give mutual funds leeway to enter the retirement market

Broadly, mutual funds have two demands in this space. The first demand is that SEBI registered mutual funds should be allowed to launch pension oriented retirement schemes with the same tax benefits as NPS. Mutual funds have also demanded that they be permitted to manage funds on behalf of insurance companies as is the practice globally. That way insurance companies can outsource fund management for a fee and focus on product origination and sales.

Many of these mutual fund demands have been raised for a number of budgets but not much has moved. It is hoped that this budget will mark a shift.