Should the amendment proposed in the Finance Bill go through in its present form, and if implemented from April 1, one can expect wider implications from the move.Indexation benefit for debt mutual funds will be removed and will be subject to short-term cap gains and will be taxed at marginal rates, which will result in fixed deposits as a more attractive investment.
Once the amendment, which was passed in Lok Sabha without a discussion (leaving the House adjourned to meet again on March 27) goes through, then tax arbitrage on long-term debt schemes (more than three years) will be gone and to that extent it will now compete with other existing debt instruments.
This could slow down new flows into debt schemes.At present, debt schemes AUM (ex-liquid) at Rs 8 lakh crore is 20 per cent of total industry AUM. The yield thereof is half of equity funds, which indicate that contributions for AMCs from debt funds are lower. Income from debt mutual funds that invest up to 35 per cent in equity shares of domestic companies will be taxable at the applicable rate as income from equities in such funds does not constitute interest income.
The amendment will have significant structural changes to the way we invest. For mutual funds to get investor interest, will now depend on their ability to add extra ‘risk adjusted returns’ and not because of any tax arbitrage. The tax arbitrage that was available at an ‘instrument’ level seems to be getting evened out across the board.
However, this will benefit the corporate bond market where there will be renewed interest from retail investors, which can also add depth to liquidity implying a better pricing for the end customer. It is certain to also impact both gold funds and international funds. As a result, bank fixed deposits will become more attractive as both debt funds and bank fixed deposits will be subject to the same taxability of maturity proceeds.
This move may have a negative impact on all debt funds, particularly in the retail category, as ultra-high net worth and high net worth individuals may choose to invest in secure alternates like bank fixed deposits.
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.Interestingly, MFs have seen outflows from debt schemes, in spite of the tax benefit.
The only one that saw inflows was the spate of target maturity funds which were passively holding Gsecs, mimicking FDs but with tax benefits. Investors may avoid redemption even after three years now as incremental income from these investments may remain tax efficient.
