The top brass of the Rs8 trillion Indian mutual fund industry will soon meet officials of the Central Board of Direct Taxes (CBDT), seeking parity in tax treatment with life insurance products. The industry, facing outflow of funds and migration of agents to insurers following regulatory changes, is unhappy with proposals in the new draft of the Direct Taxes Code (DTC) that seeks to withdraw tax benefits.
Earlier this week Insurance Regulatory and Development Authority (Irda) officials, along with top insurance company executives, met CBDT over tax exemptions for unit-linked insurance plans (Ulips).
At present, tax-saving mutual fund schemes—also known as equity-linked savings schemes, or ELSS—enjoy tax exemption at all stages of investment, as they fall under the so-called exempt-exempt-exempt (EEE) category. The initial contribution is allowed as a deduction from an investor’s income and any appreciation on this investment is also exempt from tax. Any withdrawals either on maturity or during the course of investment also does not attract any tax.
Under the latest draft of the proposed DTC, there is no mention of ELSS schemes, either in the deductible clause or under the instruments eligible for the EEE category. Fund managers interpret this as an indication of the government’s intention to remove the tax benefits.
Mutual funds believe this will kill the product. U.K. Sinha, chairman of UTI Asset Management Co. Ltd, said the tax advantage is the unique selling proposition of these schemes and the withdrawal of this benefit is unfair.
“These products are not included under the new draft, whereas similar products under the parallel regime will continue to enjoy exemption,” he said. “We will impress upon the government to remove the arbitrage and create a level playing field.”
The tax treatment for ELSS on the line of life insurance products will top the agenda of the the industry lobby when it meets CBDT this week.
“When we had met last time, they had said the schemes would be included in the new draft. But we are shocked to see they do not find a mention in the new draft too,” said H.N. Sinor, chief executive of industry lobby Association of Mutual Funds of India (Amfi). Dhirendra Kumar, chief executive of Valueresearchonline.com, a Delhi-based mutual fund tracker, said under the new regime, the concept of ELSS no longer exists. “The government is looking for long-term investments. So fund managers should design new savings products that match the structure of new pension system. If they do it, they will become eligible for the EEE category.”
Other demands include a review of the treatment of long-term capital gains. At present, capital gains made on investments of at least 12 months are considered long-term capital gains and exempt from tax. But the new tax code proposes that capital gains from equity-oriented funds would be considered income and taxed at rates applicable to the individual.
Tanwir Alam, head, retail sales, IDFC Asset Management Co. Ltd, said the removal of tax exemption for long-term gains is the bigger worry for the industry. “Taxes could potentially wipe out whatever appreciation you get from the investment,” he said.
DTC will also take away the tax arbitrage available to corporations. Investment in debt funds incur lower taxation than other instruments, making it an attractive investment vehicle for firms. Debt funds account for 75% of the mutual fund industry’s assets. Almost all of this comes from corporations.
Institutional investors park short-term treasury funds in mutual funds primarily to enjoy a tax arbitrage. While income from their treasury operations attract the corporate tax rate of 33.99% (including surcharge and education cess), debt funds attract 28.5% tax on dividend income.
Kumar of Valueresearch said under the new tax code, the tax arbitrage will vanish. “Liquid funds will become less attractive.”