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Short-term fixed maturity plans stay in gray area of tax

The regulations further require that if a liquid fund or plan has invested in a fixed rate asset, the remaining tenure of the asset has to be one year or less.

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MUMBAI: Will short-term fixed-maturity products (FMPs) have to pay dividend distribution tax (DDT) like liquid mutual funds? In response to a query from the Association of Mutual Funds in India (Amfi), chartered accountants BSR&Co, formerly Bharat S Raut & Co, have clarified that they are not the same.

BSR’s viewpoint, a copy of which is available with DNA Money, is of extreme importance because if short-term FMPs get categorised as liquid funds, they will have to pay a higher DDT of 25% compared to the current rates of 12.5% for individuals and 20% for corporates. This would lessen the tax arbitrage available to FMP investors.

As on March 31, 2007, FMPs had a massive Rs 88,317 crore as assets under management (AUM), which form around a quarter of the Indian mutual funds industry’s assets. This clearly tells us that FMPs are bread-and-butter products for mutual funds.

A Sebi circular contains a clear-cut, watertight definition of the term “liquid fund schemes and plans.” Only schemes which invest less than 10% of their assets in instruments that need to be marked-to-market can be called liquid. Discounted instruments like commercial paper, certificates of deposit, and T-bills need not be marked to market.

The regulations further require that if a liquid fund or plan has invested in a fixed rate asset, the remaining tenure of the asset has to be one year or less.

Now, the design of a typical short-term FMP product is such that it invests in instruments where the balance maturity coincides with the term of the FMP. In order to eliminate the interest rate risk, it holds all investments till maturity.

Consequently, an FMP of less than one year is more than likely to satisfy both the conditions laid out in the above-mentioned Sebi definition of liquid funds. Hence, it may by default get classified as a liquid plan.

It may be mentioned here that there are no separate guidelines for FMPs. Given this logic, short-term FMPs can well come under the definition of a liquid fund.

BSR&Co says that just because short-term FMPs invest in instruments similar to liquid schemes, it does not make them the same. In an email to AP Kurien, chairman of Amfi, points out, BSR has said: “The investment objective of these funds (FMPs) is generally to provide reasonable returns to investors by investing in securities maturing in line with the tenure of the scheme and is not to provide liquidity to investors.

Construction of a portfolio is to meet the investment objective of the scheme.  A portfolio, though consisting of money market instruments only, cannot be categorised as that of a liquid fund if the objective of construction of the portfolio is not to provide liquidity but to retain holdings over a tenure to provide relatively stable returns over the scheme’s tenure”.

The email also says that FMPs may be investing in instruments that liquid funds are allowed to invest in, but the offer documents of FMPs clearly point out that the investment is not restricted to those instruments.  

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