Union Budget and Its Impact on Mutual Funds

Best Value Mutual Funds To Invest in 2023

The pre-budget discussions by the government have already started in right earnest and the capital market participants are already prepared with their wish list from the budget. However, it would be naïve to expect too many concessions in this budget, considering that the first priority of the government would be to meet its food and fertilizer subsidy bills. The next big priority would be to try and cut down sharply on the fiscal deficit to below 6%.

The Association of Mutual Funds of India (AMFI) has already submitted its wish list for Union Budget 2023 expectations with reference to mutual funds. Here is a list of the key, which shows what to expect from budget and the rationale for the change demanded.

Table of Contents

1. Best Value Mutual Funds To Invest in 2023
2. 1. Giving mutual funds parity with ULIPs
3. 2. Taxation parity between listed debt and debt mutual funds
4. 3. Put mutual fund dividend TDS at par with bank deposits
5. 4. Proposed changes to how ELSS funds are administered
6. 5. Exempting LTCG on equity funds above 3-year holdings from tax
7. 6. Bring back Section 54E benefits for reinvestment in mutual funds
8. 7. Allow mutual funds to participate in the lucrative retirement market
9. 8. Widening the definition of equity funds for capital gains purposes

1. Giving mutual funds parity with ULIPs

This has been a persistent demand of AMFI and they have sought parity for mutual funds with ULIPs on two fronts.

1. Currently, when an investor switches from a dividend plan of a scheme to a growth plan or from a regular plan to a direct plan, it is treated as a transfer of investment. This results in capital gains or capital loss liability which has dissuaded investors from switching even where it is a more lucrative option. On the other hand, Unite Linked Insurance Plans (ULIPs) are allowed to switch across plans without any capital gains implications. Hence there is demand for parity with ULIPs on this front.
2. The second area of parity with ULIPs is with respect to calculation of capital gains. Now, long term capital gains and short term capital gains on equity and non-equity funds are taxable with Mutual Funds tax rates ranging from 10% to the peak rates applicable. However, in the case of ULIPs, the money received on maturity or redemption is entirely free of tax in the hands of the recipient, which makes the ULIP more attractive than a mutual fund; despite both being investment products.

2. Taxation parity between listed debt and debt mutual funds

Currently, there is a disconnect in the way listed debt securities are taxed and debt mutual funds are taxed. Let us take the case of capital gains. Debt funds are categorized as non-equity funds and hence they have to be held for a minimum period of 36 months to qualify as long-term capital gains. However, the rule is very different in the case of listed debt securities. In case of all listed bonds and debentures as well as listed / unlisted zero coupon bonds, the cut-off holding period to qualify as long-term capital gains is just 12 months. According to experts, this has resulted in many HNIs shifting their investments from debt funds to zero coupon bonds just for the more favourable tax treatment. The demand is that to bring about parity between direct listed debt and debt mutual funds, either the cut-off for listed debt can be enhanced to 36 months or the cut-off for debt funds can be reduced to 12 months. That would bring parity in treatment and avoid tax arbitrage.

3. Put mutual fund dividend TDS at par with bank deposits

It may be recollected that effective Union Budget 2018, the dividends received on equity and debt funds are fully taxable in the hands of the recipient. However, the problem arises with the way tax deduction at source (TDS) thresholds have been set. For mutual funds (debt or equity funds), any dividend distribution above Rs5,000 in any fiscal year is subject to TDS. This creates a lot of hassles for small investors who have to go through the rigmarole of filing returns and claiming refunds. In contrast, bank deposits do not attract any TDS till the annual interest income crosses Rs40,000. This is despite dividends and interest on deposits being taxed at the same peak rate.

4. Proposed changes to how ELSS funds are administered

Currently, Equity Linked Savings Schemes (ELSS) are tax saving funds that provide income tax exemption under Section 80C of the Income Tax Act up to an umbrella limit of Rs150,000 per year. There are two changes that have been proposed for ELSS funds.

1. Currently, ELSS investments can be made in a minimum lot of Rs500 and in multiples of Rs500 only. This is forcing the mutual funds to lose out a large market for ELSS funds at the bottom of the pyramid, which can save tax and also create wealth using ELSS funds. Hence, only the minimum stipulation of Rs500 can be retained.
2. ELSS is currently only restricted to equity investments and not to debt funds. However, many first-time investors would commit greater funds to ELSS if debt option was available for conservative investors. Hence the ELSS scheme may be expanded to include DLSS (debt linked savings scheme) also under its umbrella.

5. Exempting LTCG on equity funds above 3-year holdings from tax

Long-term capital gains on equity funds were not taxed till Budget 2018. However, since April 2018, any long-term capital gains on equity funds (held for more than 1 year) are taxed at a flat rate of 10% above Rs100,000. This creates a rather piquant situation for longer holdings. Even if an investor sells the equity funds after 10 years, the entire gains above Rs1 lakh will be taxed at a flat rate of 10% without indexation benefits. In contrast, debt funds held beyond 3 years give indexation benefits bringing their effective tax impact to less than 10%. To rectify this situation, it is proposed that equity funds held for over 3 years be made fully exempt from long-term capital gains tax.

6. Bring back Section 54E benefits for reinvestment in mutual funds

Till the fiscal year 2000-01, there used to be two dedicated income tax sections (Section 54EA and Section 54EB). There were means to give exemptions to investors if long-term capital gains were reinvested in mutual funds with an appropriate lock-in. Post-2001, this facility was removed for mutual funds and Section 54EC was introduced which only gave this benefit for infrastructure bonds. One way to encourage investors to plough back their capital gains into mutual funds is to extend Section 54EC benefits on exemption from capital gains tax to mutual funds also, as was the case till year 2001.

7. Allow mutual funds to participate in the lucrative retirement market

That is a huge opportunity for mutual funds and there are two demands here. Firstly, it is proposed that SEBI-registered mutual funds be allowed to launch pension oriented retirement schemes with the same tax benefits as NPS and other existing pension plans. In addition, mutual funds should also be allowed to manage funds on behalf of insurance companies as is the practice globally. This will allow insurance companies to focus on selling with the fund management aspect taken care of by the mutual funds.

8. Widening the definition of equity funds for capital gains purposes

Finally, there is a demand to expand the definition of equity funds to include gold funds, gold ETFs as well as fund of funds (FOFs) that invest more than 65% in equity funds/equity ETFs. Also, gold funds are losing out to sovereign gold bonds which have capital gains exemption if held beyond 8 years. A greater level playing field for gold funds and gold ETFs have been called for.