A veild threat from the banking regulator has left many mutual fund managers with worry lines. They are beginning to fear that at the advice of the Reserve Bank of India, the government may take the fizz out of certain debt schemes that have helped them fatten their asset book as well as served as a quick money parking zone for corporates and banks.
At a recent conference with money market dealers, RBI deputy governor Shyamala Gopinath hinted that “since MF fixed income products enjoy certain tax exemptions not available to banks”, there may be a case to address this through regulations.
The remark did not go unnoticed in the financial market. Ms Gopinath was referring to the liquid plus MF schemes that give investors a higher return and a clear tax advantage over bank fixed deposits (FDs). For instance, while bank FDs, for a minimum period of seven days, would fetch about 3-3.25% per annum, the return on liquid-plus scheme could be 4.5-5%. Besides, interest income on FDs would be taxed at 33% like any other income, but the dividend distribution tax (DDT) — which fund houses deduct before giving investors the dividend — is at 22% for corporates and 14% for individuals. Dividends can be paid by MFs on either a daily, or weekly, or fortnightly, or monthly basis.
Out of the Rs 7-lakh crore MF corpus, around Rs 2.5-Rs 3 lakh crore would be in various liquid-plus scheme. The central bank’s concern emanates from a crunch that financial markets and the thinly capitalised fund houses may face, if there are rapid withdrawals by large investors as it happened in the weeks after the Lehman collapse. A tax advantage has only deepened the concentration of funds in such schemes.
“It’s a matter that’s more and more catching the attention in recent times,” said Phani Shankar, head of financial markets, ING. But any tinkering on the tax front may have a significant impact on the sector. According to Sunil Jhaveri, who heads MSJ Capital & Corporate Services, a leading MF advisor, “The liquid/liquid plus category will get impacted by almost 15-20% over a period of time. At least individuals will prefer bank deposits (for longer periods) over liquid schemes as there will be certainty of returns and no tax advantage for parking funds in liquid schemes.”
Sensing that the tax arbitrage window may be shut in future, fund houses are preparing their counter-argument. “You can’t compare between FDs and debt schemes. A higher tax on FD interest may be justified since there is an implicit guarantee from the government and RBI that banks won’t fail,” said the CEO of a large asset management company.
‘Liquid plus’, as a product, was designed by the MF industry to overcome the disadvantage in liquid schemes where the DDT was hiked to 28%. While in liquid schemes, the investment happens in money market instruments and the average maturity is 90 to 120 days, liquid-plus schemes hold even more than one-year papers and the average maturity is 170-180 days (which explains the higher return).
Under the present tax regime, all debt schemes, such as short-term and long-term income fund, monthly income, balance fund, gilt and floating rate fund, enjoy a DDT of 22%. But wholesale investors prefer liquid-plus schemes as these generate a higher return.
The MF industry, which is already under strain due to the recent Sebi notification of not charging any upfront load on equity schemes, is closely watching the development. After the adverse impact on sales and distribution of equity-related products, a hike in DDT, they feel, could deal a body blow to the industry. Interestingly, even if the tax rate does not go up, Sebi can make liquid-plus schemes unattractive by making it mandatory for funds to mark-to-market all debt securities with more than 90-day maturity.
Source: http://economictimes.indiatimes.com/personal-finance/mutual-funds/mf-news/MFs-fear-loss-of-tax-advantage-in-debt/articleshow/5460717.cms
At a recent conference with money market dealers, RBI deputy governor Shyamala Gopinath hinted that “since MF fixed income products enjoy certain tax exemptions not available to banks”, there may be a case to address this through regulations.
The remark did not go unnoticed in the financial market. Ms Gopinath was referring to the liquid plus MF schemes that give investors a higher return and a clear tax advantage over bank fixed deposits (FDs). For instance, while bank FDs, for a minimum period of seven days, would fetch about 3-3.25% per annum, the return on liquid-plus scheme could be 4.5-5%. Besides, interest income on FDs would be taxed at 33% like any other income, but the dividend distribution tax (DDT) — which fund houses deduct before giving investors the dividend — is at 22% for corporates and 14% for individuals. Dividends can be paid by MFs on either a daily, or weekly, or fortnightly, or monthly basis.
Out of the Rs 7-lakh crore MF corpus, around Rs 2.5-Rs 3 lakh crore would be in various liquid-plus scheme. The central bank’s concern emanates from a crunch that financial markets and the thinly capitalised fund houses may face, if there are rapid withdrawals by large investors as it happened in the weeks after the Lehman collapse. A tax advantage has only deepened the concentration of funds in such schemes.
“It’s a matter that’s more and more catching the attention in recent times,” said Phani Shankar, head of financial markets, ING. But any tinkering on the tax front may have a significant impact on the sector. According to Sunil Jhaveri, who heads MSJ Capital & Corporate Services, a leading MF advisor, “The liquid/liquid plus category will get impacted by almost 15-20% over a period of time. At least individuals will prefer bank deposits (for longer periods) over liquid schemes as there will be certainty of returns and no tax advantage for parking funds in liquid schemes.”
Sensing that the tax arbitrage window may be shut in future, fund houses are preparing their counter-argument. “You can’t compare between FDs and debt schemes. A higher tax on FD interest may be justified since there is an implicit guarantee from the government and RBI that banks won’t fail,” said the CEO of a large asset management company.
‘Liquid plus’, as a product, was designed by the MF industry to overcome the disadvantage in liquid schemes where the DDT was hiked to 28%. While in liquid schemes, the investment happens in money market instruments and the average maturity is 90 to 120 days, liquid-plus schemes hold even more than one-year papers and the average maturity is 170-180 days (which explains the higher return).
Under the present tax regime, all debt schemes, such as short-term and long-term income fund, monthly income, balance fund, gilt and floating rate fund, enjoy a DDT of 22%. But wholesale investors prefer liquid-plus schemes as these generate a higher return.
The MF industry, which is already under strain due to the recent Sebi notification of not charging any upfront load on equity schemes, is closely watching the development. After the adverse impact on sales and distribution of equity-related products, a hike in DDT, they feel, could deal a body blow to the industry. Interestingly, even if the tax rate does not go up, Sebi can make liquid-plus schemes unattractive by making it mandatory for funds to mark-to-market all debt securities with more than 90-day maturity.
Source: http://economictimes.indiatimes.com/personal-finance/mutual-funds/mf-news/MFs-fear-loss-of-tax-advantage-in-debt/articleshow/5460717.cms
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