Tough Times for Non-Equity Funds

Posted On Friday, Jul 18, 2014


Generally, it is said "Law is the system of rules of conduct established by the sovereign government of a society to correct wrongs, maintain the stability of political and social authority, and deliver justice". With Arun Jaitley - a student of Law and currently at the helm of finance presenting his maiden budget should have been expected to correct the wrongs atleast to begin with. And yes, he clearly played his dice to correct wrongs in the Mutual Fund (MF) industry.

Non-equity oriented MFs would now qualify for long-term capital gains (LTCG) tax only after a holding period of three years from the date of investment. Earlier this period was 1 year from the date of investment. LTCG tax for non-equity oriented MFs will now be calculated at 20% plus indexation benefits. Earlier the investor had a choice of calculating LTCG at 10% without indexation or 20% plus indexation, whichever was lower.

The Finance Minister says that the objective of these changes is to remove the tax arbitrage between bank deposits and debt MF investments. However this will adversely affect the retail investors. Here`s how:

The Economics of Individual versus Group

Honorable Finance Minister, from a tax perspective, the ambit of debt MF investments cover a wide range of products and not just the FMPs that you seek to penalize. It`s akin to "Punishing the Innocent along with the Guilty".

The world of investing has moved farther than the traditional form of investing in which only two asset classes i.e. equity and debt prevailed. Therefore, earlier there were only two asset classes equity and non -equity which was the debt category. But now this non equity world has a gamut of useful products from an investor`s perspective that help them reach their financial goals. These include asset allocation funds, Equity and other Fund of Funds and Gold ETFs, etc which are in themselves efficient and useful products for a retail investor that helps in easy allocation and investment.

I believe by penalizing taxes on the non equity category in the wake of stopping arbitrage, Finance Minister has hampered the usefulness of these products and more so created doubts in the minds of MF investors as far as the certainty of the taxes on various MF products go. The impact of these changes goes far beyond the envisaged objective and it primarily happens because it does not distinguish between debt funds and other categories of funds.

All investments made earlier in any of these non-equity oriented MFs will be subject to the new tax structures implying a significant change in one`s tax liability and financial planning. Ideally a road map for these changes should have been put into place and these changes should have been only limited to debt oriented MFs.

Correcting the Wrongs

Mr. Finance Minister, if we were to believe in the message of "acche din" to which India unanimously voted, we expect that it`s only the guilty that are punished and not at the expense of the Innocent - that`s truly what "acche din" meant to us.

One important technicality surrounding investments that requires immediate attention in terms of correcting the wrong is the Equity Fund of Funds category in the Mutual Funds space.

I wish I had the privilege to represent my case through a great lawyer like our Finance Minister; it would have a decision in no time that we all have been urging for years.

It`s as simple as if A=B and B=C, then proving that A=C.
In true sense, If Equity Fund = “Equity Oriented” Fund
Then portfolio holding 5 Equity Funds =?
Our Finance Minister said “Equity Oriented”...
No, in my view he got it wrong, it`s the opposite - its "Non Equity Oriented"

For even a kid, it`s an easy answer. However, it defies logic and in the (im)practical financial world that we live, it`s classified as a non equity oriented fund - a category which is predominantly debt and hence taxed as a debt category and not as an equity category.

Yes, in reality, a portfolio of Equity Funds - an Equity Fund of Funds is categorized as a non equity fund whereas it should really be in my view truly an Equity product.

Earlier the Equity Fund of Funds category was already treated inferior as compared to Equity Funds. The current budget proposals further the agony by increasing the holding period to three years from one year for classifying for long term capital gains which will be taxed at 20% with indexation. This means that the option with the investor for the lower bound of 10% has also been done away with. This is indeed regressive for investors and should be corrected immediately.

Equity Fund of Funds is a great product where a fund manager chooses other fund managers in which he invests after thorough research and analysis of all the funds under consideration. Isn`t it better than a layman investing on his own without adequate knowledge and time. The investor is not able to do rightful justice to his hard earned money. There is an alternative and efficient way which can change the way a layman puts his savings to work. But now shies away just because new tax proposals are adversely working towards bringing this better way of investing from rising to its potential.

We hope that our Finance Minister would not wait for another budget to correct the wrongs and start with making the equity fund of funds to be classified as an equity product.

Along with that I also believe that Finance Minister would differentiate between debt funds and other funds in order to set pace with the range of financial innovation that has been continuously evolving for the betterment of retail investors. Mutual Fund is in dire need for reclassification of its product suites in a logical manner such that it lays down proper tax treatments and incentives as required - thereby seeking to punish only the guilty and spare the innocents. This will provide us to look forward towards truly "Acche Din".

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. Please visit – to read scheme specific risk factors.

Above article is authored by Quantum.

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