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No Easy Choices for AMCs as They Stop Issuing FMPs

There are no easy choices for Mutual Fund Asset Management Companies. After Budget 2014 raised the tax on debt mutual funds, they have pulled out Fixed Maturity Plans from the market, even returning money collected to investors (before the fund would have actually launched).

FMPs have more than 160,000 cr. invested – most of which will mature in a year. That money will not come back to new FMPs – and assuming a 9% return and an average of 20% tax, the tax collections will be more than Rs. 2800 cr. That’s the stake on the table now.

Some AMCs want SEBI to fight for them. Yet others want SEBI to let them make the FMPs open-ended so that investors get to stick around for 36 months.

FMPs can be moved to open-ended, but there are high operational costs. They’ll have to change the mandate, get investor approval (90% must approve) and then, offer automatic exits to those that didn’t want it.

These costs will have to be born by the AMC. SEBI will probably tell them that, and might not easily approve the large changes in mandate. (FMPs lock in the yield in an early transaction. An open ended fund will need a more flexible mandate)

Will the Finance Ministry Help?

No. They’ve decided that the loophole has to be closed, and FMPs of less than three years must involve paying short term capital gains tax.

In effect they’re telling us “long term is three years or more”. If this is the signal to debt markets this time, it is likely they do this to equity markets next year.

I don’t disagree entirely. One year is too short a term perhaps. And we can expect this three-year rule to hit equity markets soon.

In that context, no one should refuse the FMP investors a choice to stick around for two more years. If three years is what’s needed to get your gains tax free, then a stretch to three years isn’t a bad idea.

Lesson Learnt: Don’t Depend on Tax Arb

While I have been guilty of recommending this tax arbitrage, it was legal and visible. It’s taught me this again: don’t rely on tax rules for your longer term investments. (Or, apparently, even your shorter term investments)

To me, an FMP was an anomaly. You buy a bank deposit for one year, you pay tax on the interest. But you buy a mutual fund that buys the same bank deposit, it pays no tax, and then,by virtue of the magic tax arb, you also pay no tax. I suppose the taxman thought of it that way as well.

What I would like, though, is for them to think of real estate in the same way. If I own five houses, why should I pay no tax on selling one at a profit, if all I did was to buy another house? That’s blatantly unfair, and deserves to be removed as well. In terms of relatively unfair laws, the mutual fund one was benign compared to the massive arb in real estate. They need to remove that as well, and I wouldn’t be half as sad.

(And if you’ve bought a house for the tax arb, please note: the tax freedom is likely to go away)

If you asked me, I would recommend one thing:

  • Let this new tax rule apply only to investments made after the Budget day. This is the spirit of non-retrospective taxation. I hope FinMin listens.
  • D.Rama says:

    I had a few doubts, hope you have time to clarify:
    1. If income from Debt Mutual Funds is considered as short term gain (if sold within 3 years), can those gains be offset against short term losses in equity investments? What about losses in speculative income (F&O?).
    2. If this short-term gains is added to income and then taxed, does it mean, if I’m in a lower tax bracket (let’s say 3-5 lakhs pa), I will be taxed at only 10%? Currently short term equity gains are taxed at 15% regardless of tax bracket, I think.
    3. If in future, long term equity investments are also likely to be taxed, will there be an equivalent offset for long term losses in equity as well? What about investments in dud companies, where companies have simply vanished? How would I offset my losses in those?
    Thanks & Regards

    • short term gains can be offset against short term losses in equity. F&O is actually business income so no, they can’t be set off against those losses (except if they are hedges).
      short term debt gains are taxed at your slab, yes.
      Long term equity – I don’t know how it will happen, but I believe it will happen. Offsetting losses in dud companies = if equity gains are taxed you can then offset…

    • Sundar says:

      Today I just learnt from my CA that short term gains in equity can be set off against F/O losses for the same year. I was surprised but he was sure.

  • mintdesai says:

    I think this retrospective taxation is like cheating.
    Suppose I invest in tax free bond today and tomorrow they say that it is not tax free.
    I can be totally screwed.
    GOI must honor their system properly.