Mutual Funds move court to avert account freeze by I-T

MUMBAI: The country's mutual fund industry is battling a Rs 500-crore tax demand on interest earnings from some of their earlier investments in securitised papers. In order to pre-empt tax authorities from freezing their bank accounts, fund houses have moved court challenging the order.

Leading mutual funds including UTI MF, SBI Mutual Fund, HSBC AMC, Birla Sun Life MF, Reliance Mutual Fund, Religare and Kotak have filed writ petitions, praying for a stay, before the Bombay High Court.

Even though MFs are exempt from paying tax on their income from investments, the Income tax Department believes that income from securitised instruments, better known as pass through certificates (PTCs) in financial markets, are taxable. Close to 20 MFs have received notices from the tax department.

PTCs, similar to bonds and debentures, are issued by special purpose vehicles that 'pass' the interest and principal amounts from underlying loans or other assets to holders of the certificates. Banks transfer their loans to SPVs to create capital headroom for giving more loans. Securitisation deals, backed by law and Reserve Bank of India regulations, have been going on for close to a decade.

The tax claims pertain to assessment years 2007-08, '08-'09 and '09-'10. "It's an interpretational issue. Mutual funds are exempt from tax on their income from investments. Funds have moved court in the interest of investors and the financial market," said HN Sinor, chief executive of AMFI, the apex body of all the registered asset management companies.

The tax department may have been emboldened by one of the largest private MFs which decided to pay tax, said a market source.

According to fund managers, investors could have been seriously impacted as any possible move to freeze bank accounts will stall redemptions. With tax officials trying to meet their targets and corporates keen to stay liquid in a tight money market, the issue could have taken a serious turn.

While the court did not issue a stay order on Tuesday, the division bench comprising Justice DY Chandrachud and Justice MK Sanklencha, while hearing some of the petitions, asked the tax department to maintain status quo. Some of the cases will come up for hearing on Wednesday.

IL&FS acted as the trustees for the securitised papers which attracted the taxman's attention. "Since the vehicle that issued the papers showed nil income and is not in a position to pay tax, the department has made demands on mutual funds. Many of the PTCs have matured," said a person familiar with the matter.

While AMCs pay tax on the fee they earn, mutual funds are spared by law from paying tax as they hold securities on behalf on investors. In its plea, UTI MF said, "The income of beneficiary mutually fund is exempt from the tax under Section 10 (23) (d) of the Act. Therefore, if the income tax is exempted in the hand of beneficiary there is no question of assessing the same in the hand of trust."

Fund houses fear that if the tax department's claim is upheld, the securitisation market, where MFs are large investors, will come to a standstill.