What Ms Nirmala Sitharaman Needs to Do for the Indian Mutual Fund Industry in Budget 2024

January 20, 2024 Mutual Fund

In the two terms, the Modi-led-NDA government has done an impeccable job of rolling out and implementing certain structural reforms, such as…

✓ Skill India (aimed at improving the skill set of youth and making them employable)

✓ Startup India (to promote the culture of entrepreneurship and innovation)

✓ Make in India (to promote manufacturing in India)

✓ Production-Linked Incentive Scheme (for various sectors in the manufacturing space)

✓ Introduced numerous schemes for farmers

✓ Digital India (to make India a digitally empowered society)

✓ Unified Payment Interface or UPI (which made transacting online so much simpler)

✓ Focused on developing core infrastructure (roads, railways, ports, etc. to improve connectivity),

✓ Housing for the poor through the Pradhan Mantri Awas Yojana,

✓ Financial inclusion through Jan Dhan Yojana

✓ Ayushman Bharat Yojana – the healthcare scheme for the poor

✓ Introduced several other social security schemes for the poor

✓ The Direct Benefit Transfer scheme (aimed at transferring subsidies and other benefits directly to the beneficiaries’ bank account)

✓ Simplified the indirect tax structure with the Goods & Services Tax or GST

✓ Enacted the Insolvency and Bankruptcy Code (giving powers to the lender to suspend the board, sue promoters and ensure speedy recovery),

✓ Set up bad banks (as part of a wider strategy to clean up the balance sheets of banks),

✓ RERA (a quasi-judicial body regulating builders and developers)

…and many more.

The Securities and Exchange Board of India (SEBI), as the capital market regulator, too in the last decade has made sweeping reforms in the interest of investors – whether it’s the advertisement code (for fair and truthful disclosures), simplification of IPO process, benchmarking of performance of fund houses, rationalisation of expense ratios, mandatory nominations, greenlighting of passively managed ELSS and Bharat Bond ETF, introduced regulations for REITs, AIFs, and more!

Backed by all these, today India is looked up to as a promising investment destination and perceived as a “bright spot” in the global economy, reporting the fastest GDP growth (of over 6.5%) among the major economies.

The Indian equity market, i.e. the bellwether S&P BSE Sensex, as a result, has soared in the last decade and generated a CAGR of over 12% with all-round participation from investors (retail, High Net Worth Individuals, Domestic Institutional Investors, and Foreign Portfolio Investors).

The AUM of the Indian mutual fund industry has crossed Rs 50 trillion, and so has the share of its AUM-to-GDP to around 15% from single digits a decade ago.

But while the popularity of mutual funds as an investment avenue has increased (evident from the rise in folios and inflows), their share in the total household savings is just around 6.0%, according to the RBI data. This means, much needs to be done for penetration of mutual funds as a financial product.

While AMFI, along with its members (the fund houses), distributors and investment advisors, are engaging in investor education, I believe the mutual fund industry deserves its share of reforms by tweaking certain tax rules.

For instance, at present, there is a contrast in the tax treatment for United Linked Insurance Plans (ULIPs) and equity mutual funds, while both are essentially investment plans. In the case of ULIPs, currently, if the annual premium is less than Rs 2.5 lakh, the returns or the capital gains made are not subject to tax. Whereas the realised gains in the case of equity mutual funds are subject to Short Term or Long Term Capital Gains Tax, as the case may. This tax treatment disparity is bizarre and unfair.

Also, for intra-scheme switches, i.e. switching of investment within the same scheme of a mutual fund from Regular Plan to Direct Plan or vice versa, or from Dividend Option (now known as IDCW Option) to Growth Option or vice versa, there should be no capital gain tax implications as the investor is simply shifting from one plan and/or option and not redeeming per se.

Another anomaly is the tax treatment of equity Fund of Funds (FOFs). The government currently considers these as debt-oriented schemes for taxation, which beats all logic. Why should equity FoFs be considered a non-equity scheme when the mandate is to invest in an equity-oriented fund? Similarly, why should International Mutual Funds with dominant exposure to equities and offering investors geographical diversification be considered debt funds? The government should address these concerns and consider equity FoFs as well as international mutual funds investing in global equities, like equity funds, for taxation.

The government should also consider reinstating the indexation benefit for debt funds, which was removed with effect from April 1, 2023, taxing both short term and long term capital gains on debt funds at the marginal rate, i.e. as per one’s income-tax slab. The indexation benefit could encourage investors to debt mutual funds.

[Read: Debt Mutual Funds are Now at Par with Fixed Deposits for Taxation]

The change in tax rule for debt mutual funds is also mindlessly made applicable to gold ETFs and gold saving funds — treating them as debt-oriented schemes — while their underlying portfolio is invested in gold. The mutual fund industry and investors could benefit if Finance Minister, Ms Nirmala Sitharaman looks into these discrepancies.

Other than the tax policies, given that Indian bonds would now be part of the JPMorgan Global Bond Index and Bloomberg indices from mid-2024 onwards (expected to bring billions of dollars of foreign money into the Indian debt market), the government should also introduce Debt Linked Saving Scheme (DLSS) on the lines of Equity Linked Saving Scheme (ELSS). DLSS shall enable small investors to participate in bond markets at low costs and lower risk compared to equity markets.

Likewise, to channelise retirement savings, a Mutual Fund Linked Retirement Scheme (MFLRS) with the same tax concessions available to the National Pension System (NPS) should be permitted. At present, a majority of NPS subscribers are from the government and organised sector. The MFLRS could target individuals who are not subscribers to NPS, especially those from the unorganised sector, providing them with an option to save for a vital long-term goal such as retirement coupled with tax benefits. This would channelise the long-term savings of retail investors into mutual funds, enabling them to plan for retirement.

Ms Sitharaman, in December 2023 has already stated that there won’t be any “spectacular announcements” in the Interim Budget 2024. The Interim Budget 2024 is a ‘Vote on Account’ to grant the expenditures for the interim period until the outcome of the Lok Sabha election. But in the July 2024 full budget, if whichever party or government is voted to power implements many of these suggestions, it could benefit the Indian mutual fund industry and investors at large.

Happy Investing!

This article first appeared on PersonalFN here