Certain Budget proposals warrant a relook by FM

The pronouncements are very relevant and timely,particularly at a time when the savings rate has gone down by around 6% as mentioned by the finance minister and when long-term capital flows have been hard to come by.

The major measures envisaged for the mutual fund industry are the much-awaited streamlining of the Rajiv Gandhi Equity Savings Scheme (RGESS),rationalisation of the securities transaction,clarity on tax on securitisation transaction and bringing infrastructure debt funds (IDFs) of the mutual funds on a par in tax treatment with the IDFs to be set up by NBFCs. In addition to the aforesaid announcements,pension funds and provident fund trusts have been permitted to invest in debt schemes of mutual funds. An unexpected development have been the hiking of dividend distribution tax (DDT) on debt schemes of mutual funds to 25% from the current level of 12.5% for retail investors (the rates for non individual investors remain unchanged at 30%).

The proposed rate now brings the DDT on a par for all debt schemes of mutual funds — overnight,short term,medium term or long term,against a lower DDT rate for debt schemes,other than overnight products.

The manner in which rationalisation has been proposed in the RGESS scheme and the DDT on debt schemes was contrary to what the market had expected. It was widely expected that the scope of the RGESS would be widened to make it more universal and,perhaps,offer an exclusive tax-savings instrument for all individuals,which would also bring in long-term inflow into the equity market.

There was a request for rationalisation of DDT in debt schemes of mutual funds,so as to make such investment attractive. There was also a request to remove the incidence of DDT altogether for investments made in debt schemes of mutual funds,by institutional investors (particularly PF trusts,etc) who were otherwise exempt from paying tax,when they invested in other debt instruments. The Budget proposals have not acceded to any of these proposals.

Why there’s a need for relook

The RGESS scheme was envisaged as a tax-savings scheme under Section 80 CCG of the Income Tax Act to provide incentives for savings above R1 lakh,carrying benefits under Section 80 C. Identifying an individual who satisfied the income criteria (up to R10 lakh per annum),and also did not have previous transaction in equity shares,made the process of obtaining investment cumbersome. The necessity of having a listed equity scheme and,therefore,close-ended with insistence of a demat account made the investment procedure inflexible. It is good to note that the modifications now propose to hike the income limit to R12 lakh per annum and,perhaps,does away with demat account as it permits investment through mutual fund units. The income limit of R12 lakh also brings in a new set of investors,those in the 30% tax bracket within the investment fold,thereby potentially enlarging the base.

However,with the current rate of inflation,the income limit of R12 lakh,now proposed,may not be adequate to save beyond R1 lakh,which is already covered under Section 80 C. This is a challenge being faced by fund houses this year. The challenge to identify and attract retail investors continues and a potentially good source of attracting long-term retail inflow in the equity market gets abated. There is a scope to have a relook and permit investment by all individuals,irrespective of the income limit,in the scheme with tax benefits under Section 80 CCG,as has been earlier permitted in similar schemes,permitting tax savings over and above R1 lakh. This could help strengthen the equity market,and also bring in long-term money to the mutual fund industry.

Debt schemes of MFs

Mutual fund investment by retail investors has primarily been in equity. Debt schemes of mutual funds have not been very popular with retail investors,and the level of awareness is also low. The debt schemes have,of late,started bringing in inflows from retail investors. The process is slow,but has been gaining acceptance. The money so mobilised was being invested by the mutual fund industry in debt securities of various maturities issued by corporates and government. This essentially is in consonance with the concept of a deepening the secondary debt market.

The debt market is not accessesed by retail investors due to lack of awareness and also because the minimum threshold of investment is much higher than in the equity market. Mutual funds act as aggregators in that market by investing the amount mobilised from retail investors into the debt market.

Higher DDT reduces the attractiveness of the investment and,therefore,could thwart the development of the secondary debt market. It is felt that the role that mutual funds can play as aggregators of retail money in the debt market should be kept in view and the proposal of enhancing DDT should be reconsidered,and it be restored to the earlier level.

The author is MD & CEO of IDBI Mutual Fund