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Budget expectations of the industry
July, 06th 2009

In recognition of the important role of the mutual funds (MFs) in mobilising savings, the avowed policy of the Government has always been to provide complete tax exemption to the equity fund vehicle, with no taxes being levied both on the asset accretion stage and at the time of distribution of returns to the investors. However, the introduction of Securities Transaction Tax (STT) upset the apple cart for MF investors in the equity schemes and created anomalies in the taxation dispensation applicable to such investors, rues Amit Bherwani, a senior tax professional in Ernst & Young.

The MF industry has come a long way with the total assets under management by the industry currently pegged at over Rs 6 lakh crore as per a recent report, he informs, in the course of a pre-Budget email interaction with Business Line.

MFs channelise long-term savings into equities and provide the small investors a safer route for participation in the equities market. But, there are some anomalies that the industry expects the Finance Minister to clarify, during this Budget.

Excerpts from the interview.


The tax-induced distortion through STT levy needs correction. While, on the face of it, the levy of STT at 0.25 per cent on one leg (redemption) of the transaction by a MF investor may appear to be on par with the STT levy at 0.125 per cent on both the buy and sell legs of transaction put through by a direct equity investor, a closer look will clearly show that there is no parity, and that the MF investor is actually in a tax-disadvantaged position.

This is because MFs at the first instance pay the STT at the time of purchase and sale of securities from the equity market. Further, when the investor redeems his investment, there is again a 0.25 per cent STT levied on the redemption.

Thus, far from encouraging small investors to channelise their savings by investing in equities through MFs, the two-stage STT levy actually discourages an investor to take the MF route.

Consider the distributions by an equity fund, which are exempted from Dividend Distribution Tax (DDT) on account of the fact that the dividends received by the fund have already suffered DDT. On the same analogy, when the MFs themselves have already paid STT while transacting in equities on behalf of the investors, there is no reason why the MF should be further subjected to STT levy at the stage of redemption of units by the investors.

On DDT exemption.

As noted earlier, the equity-oriented mutual funds enjoy complete exemption from the levy of DDT on the distribution made to the investors. However, as per the existing definition of an equity fund, it is applicable to only those funds that have a direct 65 per cent investment in the domestic companies.

While this does benefit a majority of the equity fund schemes, two niche segments the Fund of Fund (FOF) scheme and the overseas equity scheme do not qualify for the exemption. The former because it does not have a direct investment in domestic equities, but instead invests in other equity schemes, and the latter because it does not invest in domestic equities.

Given that both FOF schemes and overseas equity funds are tailored to offer risk-diversification avenues to the investor, which is one of the fundamental objectives of a MF investment, there is a fair case for including the above categories of schemes for the DDT exemption.


Traditionally, gold and real estate have been the two most-aspired asset classes for the Indian investor community. While we have seen the launch of Exchange Traded Funds in gold, which provides an alternative, hassle-free dematerialised option for investing in gold, a collective investment option for participating in the real estate sector is still missing from the scene.

The SEBI has initiated the right moves to introduce guidelines for the Real Estate Mutual Fund (REMF) product; unfortunately, this initiative has not made much headway on account of various reasons, among them being uncertainties around the tax treatment of REMF.

An initial indication that REMF would be treated on par with equity fund has not been followed-up with the necessary amendment to the tax law. This years Budget may hopefully clear the tax uncertainty hurdle, to pave the way for the launch of REMF schemes in India.

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