Planning to invest, but are risk averse? Fixed Deposits (FD) would instantly come to mind. But, there are also debt mutual funds, where you could park your money. Debt MFs have a key advantage over bank deposits, but that is set to go away.
Debt Funds enjoyed taxation benefits over term deposits parked in banks. Typically, in FDs, the capital gains are taxed at your income tax rate. In the case of debt funds, long-term capital gains, that is when such funds are held for more than three years, are taxed at 20 per cent with indexation benefits. Essentially, taxes are calculated after taking inflation into account and thus may help bring down taxes over time, if debt funds are held for the long-term.
But, now the government wants to do away with this. One of the amendments in the finance bill is that investments in mutual funds where not more than 35 per cent is in equity shares will now be taxed at the investor's income tax slab rate.
This move brings debt funds at par with bank fixed deposits. But, that will also take away the advantage or incentive investors had to park their money in debt funds over FDs, say, industry executives.
"I hope the proposed change in the Finance Bill to remove LTCG with indexation status on debt funds is reviewed. Financialisation is just happening in India and a vibrant corporate bond market needs a strong debt MF ecosystem," said Radhika Gupta, MD and CEO of Edelweiss Asset Management Company.
It has long been debated that the market for corporate as well as municipal bonds is very shallow and steps need to be taken to deepen it. In recent years, Bharat Bond Fund and target maturity funds launched by fund houses have seen good traction.
According to Gupta, this was just the beginning of what could have been a lot of innovation in the bond category.
"This is negative for the MF industry having non-liquid debt assets under management of Rs 8 lakh crore (19 per cent of AUMs) as the relative attractiveness due to tax arbitrage goes away. Liquid MFs of Rs 6.6 lakh crore will not be impacted materially as they are anyways a short-term product and there is no material change in tax attractiveness," said Adarsh Parasrampuria, an analyst at CLSA.
The amendment in the finance bill will have significant structural changes to the way we invest, says Srikanth Subramanian, CEO, of Kotak Cherry, a platform to invest in various investment products.
"For mutual funds to get investor interest, it will now have to purely be on their ability to add extra risk-adjusted returns and not because of any tax arbitrage. The tax arbitrage that was available at an instrument level seems to be getting even out across the board," he said.
Not everyone is against this move. Independent market analyst Ajay Bodke says this is a long overdue step by the government to end "favouritism" by granting tax exemptions or deductions towards one sector like mutual funds and insurance companies at the cost of others like bank FDs and post office savings.
"This was leading to artificial propping up of demand for the former at the cost of the latter," said Bodke.
Vishal Goenka, co-founder IndiaBonds, a fintech platform for investments in bonds, says taxation rules across bond investments should be uniform as this simplifies the choice for investors, who should analyse the investment itself rather than the taxation disparity.
"This (changes to the Finance Bill) creates a uniform level playing field between debt mutual fund and direct bond investment... The proposed changes will make direct bond investments by individuals more attractive," said Goenka.
Even Subramanian of Kotak Cherry feels this move to do away with long-term capital gains benefits on debt MFs will benefit the corporate bond market as there will be renewed interest from retail investors.
The Narendra Modi-led government at the centre has in the last few years, taken several steps like introducing a newer income tax regime with lower tax rates, but sans any exemptions and deductions. In the Budget this year, we saw several incentives being announced under the new I-T regime, in a way encouraging people to switch to it.
There was also a proposal in the budget to tax income from life insurance policies, other than ULIPs (unit-linked insurance plans), with an aggregate premium amount of Rs 5 lakh per annum or more from the new financial year.
This move to end LTCG benefits for debt funds should be seen against this backdrop, feel experts.
"With the government's stated intent to nudge taxpayers towards the progressive new IT regime, such harmonisation and elimination of deductions/ exemptions should be lauded," said Bodke.
On a revenue and profitability front, this move may not impact mutual funds in a big way, as a large portion of the profits come from equity funds. This could, however, aid banks in their deposit mobilisation efforts to some extent at a time the deposit growth has been lagging well behind credit growth.
"At the margin, this is positive for banks but quantum cannot be very high as bank deposits' market size is Rs 180 lakh crore versus total debt MF size of Rs 8 lakh crore," the CLSA analyst said.
