While imposition of long term capital gains (LTCG ) tax on equity mutual funds may not be directly hurting inflows, the arbitrage created in favour of Unit Linked Insurance Plans by keeping them out of the ambit of LTCG is already seeing number of investors looking to churn their existing investments out of mutual funds and into ULIPs.
Finance Minister Arun Jaitley had in his Budget speech announced the imposition of long term capital gains tax on equity gains of over Rs 1 lakh on transfer of shares or units of equity mutual funds. The mutual fund industry has already made a representation regarding this tax arbitrage available to ULIPs before the Ministry of Finance and Securities and Exchange Board of India.
A Balasubramanian, chairman Association of Mutual Funds in India (AMFI) said that the industry body has already written to the Ministry of Finance and the Sebi that since both ULIPs and equity mutual funds invest in equities, there should be parity in the tax treatment. “We have sought that the arbitrage should be removed and both ULIPs and equity mutual funds should have same tax treatment. We are hopeful that corrective measures will be taken by the government,” said Balasubramanian.
While ULIPs are products of insurance firms and are regulated by Insurance Regulatory and Development Authority of India, mutual funds are regulated by Sebi.
A couple of financial advisors in Delhi and Mumbai told that over the last few days, they have received calls from their clients asking if they should move their MF investments into ULIPs. “Over the last few days, I have been busy explaining my clients why they should not look to move their mutual fund investments into ULIPs. The tax arbitrage between the two assets ( ULIPs and equity mutual funds) and aggressive advertisements by insurance companies is playing on the minds of investors,” said a Delhi based independent financial advisor (IFA) who did not wish to be named.
After the finance minister announced to introduce LTCG on equity gains (beginning Feb 1, 2018) on sale of shares and units of mutual funds, CBDT issued a clarification stating that exemption under clause (38) of Section 10 available on long-term capital gains arising on transfer of securities (equity shares of a company, units of an equity oriented mutual fund or a unit of a business trust) will not be available. While it proposed to tax income under clause (38) of Section 10, it is important to note that the benefits available to ULIPs fall under section 10(10D) and no change was proposed in that section. This means that the amount received on partial withdrawal or maturity of ULIPs is exempt from tax and they continue to remain exempt from LTCG tax.
Even as tax arbitrage is a reality now, advisors say that it should not be taken as a reason for investors to move out of mutual funds and invest into ULIPs. “Ulips do not provide liquidity and flexibility. While the investments are locked for five years and can’t be accessed in case of any sudden requirement, even if the scheme underperforms, the investor can switch from one scheme to another scheme of the same insurer. Besides, only those who have insurance requirement should go for ULIPs as there are mortality charges involved,” said a leading financial advisor in Mumbai.
There are some who point that from the taxation point of view, ULIPs had tax arbitrage earlier too and it was in case of debt funds. While transfer of fund from debt to equity did not attract any tax in case of ULIPs, in case of mutual funds, shifting of fund from debt to equity resulted into short-term capital gains tax. “By imposing LTCG on equity gains in mutual funds, the government has brought in tax arbitrage even on the equity front,” said a mutual fund industry insider.
Mutual fund experts say that while existing investments into mutual funds may not get impacted too much by this tax arbitrage on account of LTCG, future inflows into mutual funds may get impacted.
“Even in the past, insurance products have been sold in the name of tax benefit and so investors may get attracted to Ulips in the name of tax advantage. Also, insurers will find it easier to sell products such as retirement plan, children’s plan in the name of no long-term capital gains tax,” said an IFA.