The government's proposal to double the long-term capital gains tax to 20% may have bearing on the investments into debt funds, feel experts. The finance minister has also proposed a longer lock-in period for long-term debt funds to 36 months instead of 12 months, which will lift the tax arbitrage between mutual funds and other debt products.
Milind Barwe, managing director, HDFC Mutual Fund, said, "It is a retrospective tax which will impact past investments also as the new tax liability comes into force from April 1. It is unfair for old investors as they were unaware of their tax liability when they invested into these schemes. Bringing a parity between banking products and mutual fund investments does not hold because for banking products, the principal is protected and the interest is assured."
However, the finance minister feels that in case of mutual funds, other than equity-oriented funds, the capital gains arising on transfer of units held for more than a year is taxed at a concessional rate of 10% whereas direct investments in banks and other debt instruments attract a higher rate of tax. This allows tax arbitrage opportunity. This arbitrage has hardly benefited retail investors as their percentage is very small among the investors.
"With a view to remove this tax arbitrage, I propose to increase the rate of tax on long term capital gains from 10% to 20% on transfer of units of such funds. I also propose to increase the period of holding in respect of such units from 12 months to 36 months for this purpose," said FM in his budget speech.
Suresh Swami, executive director, Price Waterhouse (PWC), said, "There is a small tax arbitrage between a bank deposit and mutual fund debt investments. Earlier, if the long-term capital gain was taxed at 10% for 12 months, old tax structure will be applicable only if you stay invested for 36 months. If the investor unwinds its investments before 36 months the new tax libility of 20% will be applicable which is what investors were paying on bank deposits and other debt investments."
As on March 31, 2004, HNIs and retail invesors have investments worth Rs 15,611 crore in money market funds, Rs 2,492 crore in gilt funds and Rs 1,90,770 crore in debt-oriented funds.
This move, however, will impact the fund industry in a big way. Over the past one year, fund houses have been trying to attract more retail investors into debt funds which was otherwise considered as reserve of corporate treasuries and high networth individuals.