Beyond the Budget

Posted On Wednesday, Jul 16, 2014

The Union Budget 2014 created a "feel good factor" for retail investors. The Income tax exemption limit was raised by Rs 50,000 to Rs 2,50,000. Deductions available under Section 80C which cover investments in PPF, Tax savings schemes of mutual funds, etc. was increased from Rs 1,00,000 to Rs 1,50,000. The interest deduction limits available under Section 24 of Income Tax Act for purchase of a house was increased from Rs 1,50,000 to Rs 2,00,000.

The only grudge retail investors should have with the Finance Minister is the blow to investors in non-equity schemes of Mutual funds. The long term capital gains taxation in these funds was changed in two ways:
a. the tax rate was increased from 10% to 20%;
b. the tenor of holding to avail of the long term capital gains tax benefit was raised from 12 months to 36 months.

Impact of budget on non-equity schemes of Mutual funds

This budget has done away with 10 % capital gain tax without indexation. Accordingly, investors need to hold their debt securities for more than three years to avail of capital gains tax waiver. The rational of putting this clause is to discourage institutional investors from indulging in using these products for tax arbitrage due to the favourable tax treatment compared with similar competing instruments like Fixed deposits which is taxed at the highest marginal tax rates. Most of the treasury departments of large corporate houses have a mix of bank deposits, FMPs, investment in liquid and duration funds etc.

The other argument is the amount which the retail investors have in products like Fixed Maturity Plans and duration products is negligible. The amount may be negligible but the number of investors would be large. It is exactly the opposite for institutional investors with few corporates contributing bulk of the money in Fixed maturity plans and duration products.

Mutual funds have a wide range of products excluding FMPs which are pre dominantly catering to the retail investors. Mutual funds have schemes like Monthly Income Plans, Hybrid fund with tilt towards debt, fund of funds, gold funds etc. The investor normally does an asset allocation based on his risk return profile. These investors would also have to hold their investment for more than three years to avail of long term capital gain benefit.

Retail investors keep money in debt funds to earn a regular stream of income, liquidity of their investments. The asset allocation of retail investors is to keep long term money in equity schemes and keep the money which may be required at a later date in debt schemes of mutual funds. With the introduction of a 'lock in period' of 36 months, the investors only option is to keep money in liquid funds. There is now no option for the retail investors pool of money which can be kept for more than one year but less than 3 years without paying the higher marginal tax rates.

The argument that mutual funds are used for tax arbitrage has some substance particularly with reference to corporate investors. But mutual funds also serve the purpose of pooling the individual savings of retail investors and investing in the debt markets. The corporate bond markets are not well developed globally which favour retail investor's participation. Retail investors need to understand the credit risk, liquidity risk and market risk of the corporate bonds which they have purchased.

Globally, investors prefer to invest in the bond markets through the mutual fund route. The corporate bond markets are underdeveloped in the emerging markets and require the backing of the regulators for its development. In the Indian context, the debt markets are developed only in the central government securities markets. The state government securities, corporate bonds and the other segment of the market are underdeveloped and have negligible trading volumes. The government needs to reconsider the interest of the retail investors in debt markets before implementation of capital gains tax rule.

Disclaimer, Statutory Details & Risk Factors:
The views expressed here in this article are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments.

Risk Factors: Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
Please visit – to read scheme specific risk factors. Investors in the Scheme(s) are not being offered a guaranteed or assured rate of return and there can be no assurance that the schemes objective will be achieved and the NAV of the scheme(s) may go up and down depending upon the factors and forces affecting securities market. Investment in mutual fund units involves investment risk such as trading volumes, settlement risk, liquidity risk, default risk including possible loss of capital. Past performance of the sponsor / AMC / Mutual Fund does not indicate the future performance of the Scheme(s). Statutory Details: Quantum Mutual Fund (the Fund) has been constituted as a Trust under the Indian Trusts Act, 1882. Sponsor: Quantum Advisors Private Limited. (liability of Sponsor limited to Rs. 1,00,000/-) Trustee: Quantum Trustee Company Private Limited. Investment Manager: Quantum Asset Management Company Private Limited. The Sponsor, Trustee and Investment Manager are incorporated under the Companies Act, 1956.

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