On the expected lines, the Budget 2018 introduced a long-term capital gains tax (LTCG) of 10% without indexation in equity mutual funds.
In his Budget speech, the Finance Minister noted that the total amount of exempted capital gains from listed shares and mutual fund units is around Rs 3.67 lakh crores as per returns filed for Assessment Year 2017-18. Major part of this gain has accrued to corporates and Limited Liability Partnership firms (LLPs).
No major impact on mutual fund industry
Fund officials believe that while LTCG tax will dampen investor sentiment in the short run, it will not pose a serious challenge for the industry. “The decision to levy LTCG tax on equity is not surprising and is unlikely to have any significant adverse impact on the markets. This still keeps equities as the most attractive asset class from a taxation perspective since the holding period to be eligible for LTCG on most other asset classes is three years,” says G Pradeepkumar, CEO, Union Mutual Fund.
Radhika Gupta, CEO, Edelweiss Mutual Fund seconds Pradeepkumar’s views. “It will not be disruptive given the way it has been implemented with grandfathering clause. Equity still remains the lowest taxed investment vehicle and LTCG tax will not impact the growing equity and SIP culture amongst retail investors,” says Radhika. The industry has collected Rs 47,002 crore from systematic investment plans or SIPs so far this fiscal. In December, the SIP inflows crossed Rs 6,000 crore, taking the total SIP accounts or folios to 1.80 crore.
Equity funds continue to be attractive
By introducing a 10% tax on dividends distributed by equity funds, the government has bridged the anomaly between equity and debt funds which pay dividend distribution tax (DDT) of 28.84% in case of individuals. “The 10% tax on dividends declared by equity mutual funds is still lower than the 30% tax on dividends paid by debt and liquid funds,” says Kunal Bajaj, CEO, Clearfunds.com, a SEBI Registered Investment Advisor.
Mis-selling of balanced funds will be curbed
Kunal believes that the DDT will clamp down mis-selling in balanced funds. “This will reduce the mis-selling of balanced funds that declare a monthly dividend out of equity gains but are misrepresented as ‘income’ products.”
"The DDT on equity oriented mutual funds will help stop mis-selling of balanced funds that declare a monthly dividend. Mis-selling has meant that the average balanced fund size is now Rs 5,092 crore vs average equity large-cap fund at Rs 2,072 crore. Also, paying a monthly dividend in equity funds is a misrepresentation of risks because underlying principle is susceptible to wild swings but the regular income lulls people into believing it is a steady product and by implication low risk too. Mis-selling is aggravated when this equity product is offered to fixed deposit investors in the higher tax brackets stating there is no tax deduction at source (TDS) and dividend is tax-free; which will no longer be the case from hereon," says Aashish Somaiyaa, MD & CEO, Motilal Oswal AMC.
Will arbitrage funds suffer?
Advisers believe that the tax changes will affect the equity savings and arbitrage fund categories. “We may see money moving out of arbitrage mutual funds which were a hit in the recent years due to tax advantages,” says Mumbai based adviser Amar Pandit.
But fund officials feel otherwise. “The tax does not affect arbitrage funds. The post-tax differential is still 20% as compared to bank fixed deposits and liquid funds, which is material, and on a performing arbitrage fund translates to extra returns of 1% annually to the investor. Investors will continue to look at the arbitrage category where funds are delivering performance,” observes Radhika.
Chase goals not tax
Chennai-based adviser D Muthukrishnan feels that a flat 10% LTCG tax is punishing for long-term investors. “They should have brought indexation benefit of 20% because paying 10% will punish long term investors. In my opinion, investors should invest by keeping their goals in mind and not taxes. Since the tax will be on gains of over Rs 1 lakh retail investors won’t be affected much,” says D Muthukrishnan.
Unit Linked Insurance Plans (ULIPs) outside the LTCG tax ambit
The 10% LTCG tax will not be applicable for ULIPs which also invest in equities. However, advisers believe that mutual funds will continue to be preferred because of liquidity and lower expenses as compared to ULIPs . “According to Section 10 (10D), the proceeds from ULIPs are tax-free if the sum assured is 10 times of the premium if held for five years. Thus, this 10% LTCG tax won’t be applicable to ULIPs. However, we believe that mutual funds are better products for long term wealth creation as they offer liquidity and lower costs as compared to ULIPs,” says Pankaj Mathpal, Managing Director, Optima Money Managers.
However, some fund officials believe that distributors may switch to selling ULIPs. “Fund houses have to realign the income distribution strategy. Dividend stripping may get controlled while the investors may end up paying tax even in the short-term. This doesn’t augment well for the mutual fund industry as ULIPs are outside LTCG tax purview and with commissions riding high on insurance mobilization, retail savings may get diverted to ULIPs,” says Jimmy Patel, CEO, Quantum Mutual Fund.