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MFs look to Budget to fulfil wishlist Detaxification
February, 09th 2008

R Anand

The Indian Mutual Fund industry has clearly come of age. From a slow and jerky start in 1992 when the size of Assets under Management (AUM) was a meagre Rs 47,004 crore, the industry has grown to Rs 556,730 crore today. A large number of investors use this route to access the capital market, resulting in a marked shift from public deposits to mutual funds.

Policy initiatives

For the mutual Fund industry to stabilise and ensure an acceptable level of transparency, it has to move to the next level of growth phase which calls for policy initiatives. New pension scheme funds, funds of public sector undertakings, trusts should be permitted to invest in mutual fund schemes. Also, Equity Linked Savings Scheme should be extended to all equity schemes with a lock-in period of three years.

To broadbase the investment portfolio, it is suggested that Section 80C of Income-tax Act, 1961 (Act) be made applicable to all equity-oriented schemes with a three-year lock-in period. The salaried class should be encouraged to invest in mutual fund schemes in additional to provident funds. Moreover, the threshold limit of Rs 1 lakh as contained in Section 80C of Act should be upgraded to accommodate this facility.

Specific Tax issues

Section 115T of Act

Currently Equity Oriented status is given only to funds that invest in equity shares in domestic companies to the extent of 65 per cent or more of its investible funds. Schemes that invest only in foreign securities or invest more than 35 per cent in such securities are not entitled to the benefit of Section 115T of Act. In view of this, the definition of Equity Oriented Fund should be expanded to include investment by the fund in the securities of foreign listed companies and also in ADRs/GDRs issued by Indian and Foreign Companies.

Fund of Funds (FOF) Schemes, which invest their funds in income oriented/equity oriented schemes of other mutual funds are deprived of the exemption granted under Section 115T of Act, since they do not directly invest in Equity Oriented Schemes. It is, therefore suggested that such FOF schemes should also qualify for the same exemption under Section 115T of Act.

Securities Transaction Tax (STT)

STT introduced by the Finance (No.2) Act, 2004 to slow down the flow of speculative money in the stock market earned Rs 6,793 crore during the period April 2007 to January 2008.

An anomaly has crept in the levy of STT on equity schemes of mutual funds in as much as the levy on purchase and sale of units of such schemes entails double levy of STT.

Levy of STT happens at the time of purchase and sale of equity shares by mutual funds and at the time of redemption of units by the unit holders adversely affecting the returns to the investors. Hence, provisions need to be suitably amended so that STT is not levied at the time of redemption of the units under equity schemes of mutual funds.

Consequent upon inclusion of Equity Oriented FOF in the definition of Equity Oriented Fund under Section 115T of Act, there will be a three-fold incidence of STT as discussed above. In order to avoid this triple incidence of STT, Equity oriented FOF may be exempted from the levy of STT.

Merger of mutual fund schemes

Mergers of mutual fund schemes are often the result of amalgamation or acquisition of AMCs or consolidation of schemes having similar objectives and nature of investments. As a result, issue of units of merged scheme to the investor in lieu of the units held by him in the merging scheme is treated as redemption from the merging scheme and fresh investment in the merged scheme.

The investor is required to bear the burden of capital gains tax even though the investment remains within the fund house. The present provisions under Section 47 of the Act do not exempt such a merger/consolidation of mutual fund schemes from the definition of transfer.

It is, therefore, suggested that the provisions of Section 47 of the Act be amended so that the aforesaid transfers are exempted from the definition of transfer and do not attract capital gain tax.

Dividend Distribution Tax (DDT)

Dividend distributed by equity-oriented schemes are exempt form DDT under Section 115R of Act.

When FOF invests in equity-oriented schemes, they derive income from such equity schemes of other funds and the aforesaid exemption is applicable. However, when such FOF itself distributes dividend to its unit holders, such exemption is not available on the ground that it has not invested its funds directly in equity shares.

Hence, such FOFs that invest 65 per cent or more of investible funds in equity-oriented schemes of other mutual funds should be treated on a par with the equity oriented funds and exemption under section 115R should be granted. These are some of the key issues confronting the Mutual Fund industry and hopefully some or most of them would be addressed in the forthcoming Budget.

The author is Tax Partner, Ernst & Young
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