The Mutual Fund Industry’s Expectation from Modi 3.0’s Full Budget

July 16, 2024 Mutual Fund

With Modi 3.0, a coalition government formed with support from TDP, JDU, and other allies, all eyes are now on the full budget for 2024-25.

Several individuals and industries have expectations from the finance minister, Ms. Nirmala Sitharaman hoping that their concerns and proposals will be heard as well addressed.

The Indian mutual fund industry too has articulated its concerns and made certain proposals for the union budget 2024-25. Among the various ones, the key proposals are the following:

1. Amend the Definition of Equity-Oriented Mutual Funds to Include Fund of Funds Investing in Equity-oriented Funds – Currently, section 112A of the Income Tax Act, 1961, treats fund of funds (FoFs) as equity-oriented if, (a) a minimum of 90% of the total proceeds of such fund is invested in the units of such other equity-oriented fund; and (b) such other equity oriented fund also invests a minimum of 90% per cent of its total proceeds in the equity shares of domestic companies listed on a recognised stock exchange. Hence, only when both these criteria are fulfilled, the FoF is regarded as equity-oriented, otherwise as non-equity-oriented, i.e. a debt scheme for taxation purposes.Now, in most cases, equity FoFs, satisfy only the first criteria. A FoF may fall short of meeting the second criterion, as the underlying equity-oriented fund by mandate has the flexibility to invest between 65% to 100% in listed stocks of domestic companies. According to AMFI, while technically equity-oriented do not need to invest a minimum of 90% of total proceeds in listed stocks, in practice, most of the EOFs do invest at least 90% in listed stocks.Hence, it is proposed or expected that the government amends the definition of equity-oriented funds to include investment in Fund of Funds schemes which invest a minimum of 90% of the corpus in units of Equity Oriented Mutual Fund Schemes, which in turn invest a minimum 65% in equity shares of domestic companies listed on a recognised stock exchange. In other words, the mutual fund industry is also suggesting dropping the second criterion of Section 112A.Consequently, by changing the definition as above, the equity-oriented FoFs will be considered on par with other equity-oriented mutual funds and listed equity shares (as ultimately the underlying funds are investing in equity shares of domestic listed companies). Simply put, what the mutual fund industry is asking for is tax parity between equity mutual funds, FoFs investing in equity-oriented mutual funds, and direct equity (listed) shares.
2. Alter the Taxability of Long Term Capital Gains Tax – At present, for listed equity shares and equity-oriented mutual funds the Long Term Capital Gain (LTCG) is taxed @10% (plus applicable surcharge and cess) only over Rs 1 lakh. This threshold limit according to the mutual fund industry is very low.Therefore, it is proposed or requested that the LTCG on listed equity shares or units of equity-oriented mutual funds be increased to Rs 2 lakh for a holding period of more than a year and up to 3 years and taxed @10%. But when the holding period is more than three years, the LTCG on listed equity shares or units of equity-oriented mutual funds be exempt.Doing so shall encourage long-term investments in equities and will help channelise more household savings into the equity markets, thus helping the Indian economy.[Read: Know About Tax on Mutual Funds in India]
3. Tax Concession in Debt Mutual Funds – Last year, with effect from April 1, 2023, debt funds were made at par with bank fixed deposits as regards taxation. The capital gains on debt funds, irrespective of Short Term Capital Gains (STCG) and LTCG were made taxable at the marginal rate of taxation, i.e. as per the assessee’s income-tax slab. The indexation benefit that, in effect, reduced the tax liability was done away with.Whereas, bonds, debentures, SDL, G-secs, etc. if held for more than 3 years (1 year in the case of list securities), are currently at 10% without indexation benefit.Thus, to iron out the disparity in the tax treatment, it is requested or proposed by the Indian mutual fund industry that the capital gain on units of debt-oriented mutual funds held for more than 3 years be taxable @10% without indexation.
4. Parity of Taxation on Gold and Gold Mutual Funds – Currently, gold mutual funds are classified as non-equity oriented mutual fund schemes, i.e. debt funds for taxation purposes. Thus, the taxation rule applicable for debt mutual funds applies even to gold mutual funds (gold ETFs and gold saving funds).Whereas in the case of physical gold (gold bars, biscuits coins, jewellery, etc.) when held for 3 years or more, the LTCG is taxed @20% with an indexation benefit available to cover inflation cost from the year of purchase. If there are Short Term Capital Gains, that is, the physical gold is sold in less than 3 years period, the STCG is charged as per the assessee’s income-tax slab.This clearly makes the tax unfavourable for gold mutual funds. The mutual fund industry is of the view that taxation for gold mutual funds, in particular, should be made attractive to reduce dependence on imports of physical. Therefore, it is proposed that gold mutual fund schemes should be taxed in accordance with capital gains taxation on the underlying commodity and not as debt /non-equity instruments.
5. Permit Any Amount to be Invested in Equity Linked Savings Scheme (ELSS) – Investment in ELSS, also known as tax-saving mutual funds, makes it possible to claim a deduction under Section 80C of up to Rs 1.50 lakh in the financial year in which the investment is made. However, Rule 3(a) of the Equity Linked Savings Scheme, 2005 (under Notification No.226/2005 dated November 3, 2005, issued by the Central Board of Direct Taxes) stipulates that the minimum amount to be invested in ELSS should be Rs 500 and it should in multiples of Rs 500.But there are practical difficulties in this rule. In the case of the inter-scheme switch facility, i.e., switching investment from other mutual fund scheme/s to an ELSS fund, when the switch amount is not exactly in multiples of Rs 500, the transaction is rejected or fund houses have to make a refund of the fractional amount which is not in multiples of Rs 500. This causes inconvenience to investors, including a loss of investment opportunity, tax benefit, adds to the operational work at the fund house, and for the fund house the rejection of investment or refund of fractional sum that is not in multiples of Rs 500, is a loss of business or inflows.Besides, even if the investor contributes or invests in multiples of Rs 500, the growth in the value of investment in ELSS available for redemption (after the 3-year lock-in period) is not in multiples of Rs 500 and would never be a round amount. In short, in today’s digital ecosystem, the multiple of Rs 500 is losing relevance.Considering the aforementioned factors, it is requested or proposed by the mutual fund industry body to amend Rule 3 of Equity Linked Savings Scheme, 2005, deleting the stipulation that investments in ELSS should be multiples of Rs 500 and permit investments of any amount, subject to a minimum of Rs 500.
6. Introduce Debt Linked Savings Scheme (DLSS) – Just as the way there is ELSS, the Indian mutual fund industry has proposed introducing Debt Linked Savings Scheme or DLSS to deepen the Indian bond market. The rationale behind this is to build a system where large companies get most of their funds from the bond markets, while banks focus on smaller enterprises. There needs to be a viable alternative platform for raising debt finance and reducing dependence on the banking system.DLSS would help channelise household savings into the bond market and help deepen it. It would provide an alternative fixed-income option with tax breaks to retail investors and help them to participate in bond markets at low costs and lower risk as compared to equity markets.The mutual fund industry body has proposed that at least 80% of the funds collected under DLSS shall be invested in debentures and bonds of companies as permitted under SEBI Mutual Fund Regulations. The funds may also be allowed to be deployed in money market instruments and other liquid instruments as permitted under SEBI MF Regulations.Further, it is proposed that investment in DLSS up to Rs 1.50 lakh be eligible for deduction under a separate sub-section and be subject to a lock-in period of 5 years. This shall make DLSS on par with bank fixed deposits as regards taxation.
7. Be Allowed to Launch Pension-oriented Mutual Fund Schemes (MFLRS) with Uniform Tax Treatment as the National Pension System (NPS) – The mutual fund industry has pointed out that at present for post-retirement pension income, there are three avenues: i) National Pension System, ii) Retirement/pension schemes offered by mutual funds, and iii) Insurance-linked pension plans offered by insurance companies.While NPS is eligible for tax exemptions under Section 80CCD, mutual fund schemes which are similar in nature, i.e., which are retirement/pension oriented, AND which are specifically notified by CBDT, qualify for tax benefit under Section 80C. At present, only a handful of Mutual Fund Retirement Benefit / Pension Schemes which have been specifically notified by CBDT qualify for tax benefit under Section 80C.The industry cited that “uniform tax treatment for pension fund and mutual fund linked retirement plan” was stated as a key feature of the union budget 2014-15, while there was no reference to it in the actual Finance Bill, disappointing the mutual fund industry.The capital market regulator, SEBI, in its “Long Term Policy for Mutual Funds” published a few years ago, had proposed that mutual funds be allowed to launch pension plans, namely, Mutual Fund Linked Retirement Plans (MFLRPs) akin to 401(k) Plan in the U.S. which would be eligible for tax benefit. It was also emphasized in the aforesaid long-term policy that similar products should get similar tax treatment, and the need to eliminate tax arbitrage.Thus, now the industry expects this to be earnestly looked into by the government, whereby it will allow fund houses to launch MFLRS and make investors eligible for the same tax concession as for NPS. Further, the withdrawals from MFLRS be made exempt from income tax up to the limits as applicable to withdrawals from NPS as in section 10(12A) and 10(12B) of the Income Tax Act, 1961.The mutual fund industry is of the view that allowing mutual funds to launch MFLRS would bring pension benefits to millions of Indians in the unorganised sector. Further, empirical evidence suggests that tax incentives are pivotal in channelising long-term savings. Also, going forward pension funds are likely to emerge as sources of funds in infrastructure and other projects with long gestation periods, as well as for providing depth to the equity market.
8. Mutual Funds Should be Notified as ‘Specified Long-Term Assets’ qualifying for exemption on LTCG under Section 54 EC – This Section of the Income Tax Act provides for exemption when investment is made in specified long-term assets, i.e., bonds issued by the National Highway Authority of India and Rural Electrification Corporation that are redeemable after the lock-in period.It is proposed that mutual fund units, wherein the underlying investments are made in the specified infrastructure subsector (as may be specified by the Government of India), be included in the list of the specified long-term assets qualifying for tax exemption on LTCG under Section 54EC. Furthermore, the investment in such a mutual fund scheme can have a lock-in period of 3 years when availing of the exemption.According to the mutual fund industry, investment in specified mutual fund schemes with Section 54EC benefit can provide an alternative investment avenue in addition to existing options to the investors and also provide them with an option to earn market-related returns. This could also help ease the burden cost of borrowing for infrastructure funding on the government.
9. Increase the Threshold Limit of Withholding Tax (TDS) on the Income Distribution by Mutual Funds – Currently, the threshold limit of Rs 5,000 per annum for TDS on income distribution or dividends on mutual funds is very low. This causes hardship to retail investors, especially those in lower tax brackets.Recognising this, it is requested or proposed by the mutual fund industry that the threshold limit for withholding tax or TDS on income distribution (dividend) on mutual fund units be increased from Rs 5,000 to Rs 50,000 p.a. to mitigate the hardships faced by retail investors.
10. Uniform Rate for Deduction of Surcharge on TDS in respect of NRIs – The amount paid/credited to NRIs whether it is dividend (i.e. income distribution) and/or capital gains upon redemption of mutual fund units are subject to TDS as per provisions of Section 195/196A. The surcharge applicable on the TDS is as per the income slab and varies depending on the amount paid/credited. The slab-wise rate of surcharge is specified in Part II of the First Schedule to the Finance Act, 2020. In addition, there is a health and education cess of @4% levied.However, in reality, there is no way for the mutual fund to know the income slab of the NRI so as to determine the appropriate rate of surcharge on the TDS to be applied at the time of making payment of dividends or redemption proceeds. Why should a mutual fund be regarded as an assessee for the shortfall in TDS, or representative assessee for that matter? Why should they be made liable in case of any shortfall in the surcharge on TDS made in respect of NRI taxpayers at the assessment stage?Nonetheless, some mutual funds are conservatively deducting the Surcharge on TDS at the maximum rate of 37% surcharge, irrespective of the amount of capital gain, while some are deducting the surcharge at the applicable rate for the actual redemption amount paid for a given transaction. In short, there is a lack of uniformity in the rate of surcharge on the TDS applied by various mutual fund houses. Consequently, there are numerous complaints from NRI taxpayers, and they are demanding a uniform rate of surcharge on TDS to be applied across all mutual funds.In light of the above, the mutual fund industry has proposed that the existing provisions for the surcharge on TDS applicable to NRIs be amended and prescribe a uniform rate of surcharge @10% on TDS in respect of dividends from mutual fund units (under Section 56) as well as the capital gains arising upon redemption of mutual fund units (under Section 111A and Sec.112A) in respect of NRIs, instead of slab-wise rate of surcharge.According to the mutual fund industry, rationalising the surcharge rate on TDS by prescribing a flat rate will facilitate ease of tax administration, without any loss of revenue to the government, and at the same time mitigate the hardships currently faced by fund houses and NRIs.

In addition to the above, the mutual fund industry body has requested the government to provide clarity on the applicability of higher TDS when PAN becomes inoperative. There are instances in the case of resident investors that at the time of onboarding the investor, the PAN was operative, however later it becomes inoperative, thus compelling mutual fund houses to withhold additional tax at the time of payment of income distribution. Remember, non-linkage of Aadhaar and PAN can make PAN inoperative.

Many of these suggestions from the Indian mutual fund industry are in the interest of investors. We need to see, if the finance minister shows regard for these worthwhile and meaningful suggestions when presenting the full budget for 2024-25 on July 23, 2024, which can make taxes less complex, bring in parity, and encourage investor participation in the financial markets.

Happy Investing!

This article first appeared on PersonalFN here