Tax on MF income to hit short-term investments

NEW DELHI: The Kelkar panel recommendation to tax a part of the mutual fund income has met with opposition from the MF industry. Industry insiders say the move is likely to reduce the appeal of the funds and change investment strategy.
The Kelkar committee on direct taxes has recommended that the income of MFs derived from short-term capital gains and interest should be taxed at a flat rate of 20% and that dividend payments to unit-holders should be exempt from tax.
The short-term capital gain made by the investor from the sale of units should be taxed at the personal marginal rate and the long-term capital gains be exempted from tax as in the case of equity.
The committee has recommended extension of this treatment to venture capital funds, private equity funds and hedge funds, with the modification that the tax rate in the case of these funds should be 30% rather than 20%.
The panel has also recommended that all investment funds must obtain PAN of investors and furnish to the tax authorities information about every single payment made to them.
However, players in the mutual fund industry have been put off by the decision to tax MFs. Mutual fund experts believe the panel recommendations may induce exit of short-term speculative money as the present tax-free regime of MF income disappears.
As an immediate impact, inflows to the MF industry are likely to slow down with investments from corporates, who park their money for a short time to secure returns that match or exceed those of banks, drying up.
If the recommendations are accepted, the first thing to vanish would be the blanket cover the MFs have enjoyed for not paying taxes under Section 10(23)(d) of the Income Tax Act.
“What Kelkar panel has suggested is that the MFs should stay out of momentum-based strategy. They instead should buy and hold to the stock as they have all the incentive to do it,� explains R K Gupta, MD of Taurus MF.
However, others feel that the tax treatment recommended by the panel still leaves the MF as an attractive investment vehicle.
Short-term capital gains and interest income would be taxed at the marginal rate of 30% for investors with high incomes, if such income is derived through direct investment in the underlying securities, but would be taxed at only 20% if derived through a MF, since dividends paid out by MFs are tax-exempt in the hands of the investor. The recommendation, they feel, is easy to administer and leaves MFs and unit-holders better off than in a straightforward ‘pass-through’ treatment.