Debt schemes of MFs lose edge over bank deposits as Budget proposes to scrap LTCG & indexation benefits
- Budget amendment proposes to do away with long-term capital gains tax on debt investments. This effectively ends the tax arbitrage that used to exist between bank deposits and debt schemes.
- Experts view this as a negative for
mutual fundsas investors may move capital from debt schemes to bank FDs or other long-term instruments like non-convertible debentures.
- According to CLSA, the measure would have a moderate to low impact on profitability, as bulk of the revenue/profitability for AMCs accrues from equity assets and non-liquid debt AUMs are neither higher growth nor higher profitability segments.
AdvertisementIt is going to be a busy weekend for mutual fund advisors and distributors, with the government proposing to change the taxation structure of debt schemes. With the change in taxation, distributors and advisors are rushing to lock in large amounts of investments from their HNI customers before the financial year ends. As per the proposed changes in the Finance Bill, investors in debt funds will have to pay tax according to their income slabs. Investors have so far benefited from indexation while calculating long-term capital gains from debt funds but this will now longer be available from 1 April, 2023. However, all investments made before 31 March 2023 will continue to enjoy indexation and LTCG benefits.
According to FY24’s Budget amendment, capital gains arising from any investments made after 1 April, 2023, in non-equity mutual fund schemes will not be eligible for long-term capital gains benefits. Mutual fund distributors have been spamming their HNI clientele all morning about these proposed changes so that they can lock in their investments before the new fiscal year to take advantage of the indexation benefits.
Explains CA Manish. P Hingar, founder at Fintoo, “This move may have a negative impact on all debt funds…We may see a shift from long-term debt funds to equity funds, and money may be directed towards sovereign gold bonds, bank fixed deposits, and non-convertible debentures in the debt category. This is good news for banks as they can attract customers with higher interest rates and increase their borrowing and saving book sizes.”
Fund houses are screaming blue murder, especially the non-bank backed ones, as the amendment has come as a complete surprise. Few fund houses wanted to go on record to speak on the subject, as they feel it is a negative for the bond funds. The government is seeking to do away with the tax arbitrage that currently existed between debt funds and bank deposits. So far interest income from bank deposits have been taxed at slab rates, while investments in debt funds of a duration of over 36 months have been taxed at a long-term capital gains tax rate of 20% with indexation benefits. Indexation is nothing but a methodology that helps reduce tax burden by adjusting for inflation. Now this option will no longer be available to debt investors.
Mutual funds are an unhappy lot as this takes away the added benefit that investors of debt schemes had over bank deposits. Srikanth Subramanian, CEO, Kotak Cherry said, "The amendment in the finance bill will have significant structural changes to the way we invest. For mutual funds to get investor interest, it’ll now have to purely be on their ability to add extra ‘risk adjusted returns’ and not because of any tax arbitrage.” The advantage of paying lower tax on a debt instrument like mutual fund will no longer be available to investors or savers. The playing field is now more even, believe experts.
However this will benefit the corporate bond market where there will be renewed interest from retail investors, and this will also add depth to the liquidity which again will mean better pricing for the end customer, explains Subramanian.
Analysts believe that this is negative for mutual funds, as debt schemes (barring liquid) contribute to 19% of AUMs and anywhere up to 14% of revenues. According to CLSA, the measure would have a moderate to low impact on profitability, as bulk of the revenue/profitability for AMCs accrues from equity assets and non-liquid debt AUMs are neither higher growth nor higher profitability segments. The measure will also not impact liquid MFs of ₹6.6 trillion materially, as they are short-term products and there is no material change in tax attractiveness. For life insurers, there appears to be no change in the taxation structure in the budget.
An unintended impact of this could be felt by non-banking financial institutions that rely on mutual funds for some of their funding requirements. With flows into debt schemes slowing after this move, NBFCs may have to rely more on bank funding than mutual funds.
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