Harish Naik (name changed), 59, works in a public sector undertaking. He recently invested a major part of his savings in debt mutual funds, given that capital gains arising from transfer of units held for more than a year on such funds is low compared to other investment avenues such as banks.
On Thursday, finance minister Arun Jaitley gave investors such as Naik and the mutual fund industry a jolt by increasing the long-term capital gains tax on debt mutual funds to 20% from 10%.
“With a view to removing this tax arbitrage (between debt funds and investments made in bank deposits etc), I propose to increase the rate of tax on long-term capital gains from 10% to 20% on transfer of units of such funds,” Jaitley said in his speech.
The will reduce capital gains and increase the tax burden. Hence, it is no more an attractive investment option, said Naik.
That’s not all. The definition of long-term has also been changed to 36 months for non-equity MFs from 12 months. The result: investors would have to stay invested longer to reap the gains. It will deter people looking for short-term (1-2 years) but safe avenues, investment advisers said.
“By raising the capital gains tax and redefining long-term, the government has made investing in debt fund less attractive,” said Gaurav Roy, co-founder and chief operating officer of Bigdecisions.in, a company that advises retail investors on financial planning.
While people in the 30% tax bracket might still find debt mutual funds attractive, people who pay lower tax (10-20%) are likely to shy away, he added.
Debt funds account for a majority of over Rs. 9 lakh crore in assets under management of the Indian mutual fund industry.
Fund houses said that the industry was not as evolved as the developed markets and the Centre’s move was not desirable.
“With the increase in tax, there is no difference now between investing in a debt funds or other options such as bank deposits. Mutual funds still remain vehicle to invest in debt instruments. But short-term investors could look at other investment avenues now,” said A Balasubramanian, CEO of Birla Sun Life Asset Management.
The industry is likely to take up the issue with the government.
Analysts say big cash-rich companies such as Maruti, Hero Moto, ACC and Reliance, which park their funds in these debt instruments, would also be hit.
“The increase in holding period and hike in tax rate for investments in debt funds will impact treasury incomes for cash-rich companies,” Motilal Oswal said.