India removes long-term tax benefits for debt mutual funds

(Reuters) - India will tax investments in debt mutual funds as short-term capital gains, according to amendments to the Finance Bill passed on Friday, a move that could strip investors of the long-term tax benefits that made such investments popular.

COMMENTARY

NAGESH CHAUHAN, HEAD OF DEBT CAPITAL MARKET AT TIPSONS GROUP, MUMBAI

"Indexation benefit from debt mutual funds has been removed and this could reduce inflows in debt mutual funds and benefit bank deposits and direct bond investments from high net-worth individuals (HNI) and family offices."

"We might see short term bonds which are in the rating range of A- to AA- to attract fresh inflows. Since these papers were not getting allocation from MF as per their risk averse investment policy and HNI investors were restricting allocation since taxation was not at par with Debt MFs."

"Risk adjusted returns in the category of A- to AA- were not much rewarding to attract HNI investors earlier, with this move (taxation parity) they would be keen to explore high yielding space."

SRIKANTH SUBRAMANIAN, CEO, KOTAK CHERRY, MUMBAI

"The amendment in the finance bill will have significant structural changes to the way we invest. For mutual fund to get investor interest, it'll now have to purely be 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 be debt MF or MLD (market-linked debentures). However this will benefit the corporate bond market where there will be renewed interest from retail investors, and this will also add depth to the liquidity which again will mean better pricing for the end customer."

NARENDRA DIXIT, HEAD – RETAIL BANKING, CSB BANK, MUMBAI

"As of now, debt mutual funds are treated as long-term investments if held for more than three years and taxed at the rate of 20% along with indexation benefits or 10% without indexation. For those with a holding period of less than three years, they are taxed according to their tax slab."

"So for investors having more than three-year horizon, debt schemes were better vis-a-vis FD (fixed deposit) in higher tax brackets. While FD always has the element of return being known upfront as rate of interest is fixed, debt funds had the taxation edge due to the above rule."

"Now with proposed change in tax rules, FD and Debt MF are at par with each other in taxation. FD carries an additional advantage of being free of interest rate risk. Customers have the comfort of knowing the final return upfront at the time of booking. The tax arbitrage of debt fund is now gone."

"Also, debt fund returns carry the interest rate risk. We feel that a lot of long term investors will gradually shift to Bank FDs now , especially in high tax brackets."

MANISH. P HINGAR, FOUNDER, FINTOO, MUMBAI

"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 safe havens 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."

"It is apparent that the government intends to remove tax arbitrage by creating a consistent tax policy across all debt instruments."

VISHAL GOENKA, CO-FOUNDER, INDIABONDS.COM, MUMBAI

"Taxation rules across bond investments should be uniform as this simplifies the choice for investors who should focus on analysing the investment itself rather than the taxation disparity."

"We welcome the proposed changes via the amendments to the Finance Bill as this creates a uniform level playing field between debt mutual fund and direct bond investment."

"We always encourage investors to have fixed income in their portfolio for adequate diversification and the proposed changes will make direct bond investments by individuals more attractive."

AJAY BODKE, INDEPENDENT MARKET ANALYST, MUMBAI

"A long overdue step by the government to end favouritism by granting tax exemptions or deductions towards one sector (MFs, insurers) at the cost of others (Bank FDs, PFs, Post Office Savings etc), which was leading to artificial propping up of demand for the former at the cost of the latter."

"With government's stated intent to nudge tax payers towards progressive New IT regime such harmonization and elimination of deductions/exemptions should be lauded."

AMIT KUMAR GUPTA, FOUNDER AND CIO, FINTREKK CAPITAL, DELHI

"Basically, they have proposed to remove tax arbitrage. Debt mutual funds were getting favourable tax treatment for indexation and long-term capital gains. That has been removed now, with this bill."

"As an asset class, debt mutual funds will get less attractive. FDs may become more popular. Banks are facing an issue of deposits also. That can increase after the announcement."

"Government's view has always been that uniform capital gains tax should be there, across all asset classes."

"But the decision does not affect the existing investor, all the existing investments will be grand-fathered."

CLSA ANALYSTS

"This is negative for MFs – Debt (ex liquid) contributes 19% of AUMs and 11%-14% of revenues."

"For life insurers, there seems to be no change to the taxation proposed in the budget and status quo remains with life savings taxed at marginal tax rate but tax arbitrage in favour of competing products such as MFs is gone now which at these valuations is a small positive for life insurers."

"NBFCs get a material part of their funding from MFs – funding proportion from banks will go up. Marginally positive for bank credit/deposits."

(Reporting by Siddhi Nayak, Bharath Rajeswaran, Chris Thomas, Bhakti Tambe and Swati Bhat; editing by Eileen Soreng and Dhanya Ann Thoppil)