Hike in dividend distribution tax, cap on banks' investments to hit fund houses

Increase in the dividend distribution tax and a cap on banks' investments in liquid mutual funds may erode fund house AUMs, says an ICRA report.

The report by ICRA estimates that the impact of the regulatory reforms regarding dividend distribution tax (DDT) and bank investments' in liquid/debt funds could lead to a decline in AUM levels by around 11 per cent in the current fiscal, as compared to March 2011 levels. According to the report, the debt fund AUM in the industry would decline by as much as 17 per cent.

Increase in DDT

The 2011-12 Budget had proposed a hike in the dividend distribution tax for corporate investors to 30 per cent effective from June 1, 2011. The corporations, that invest mainly in liquid/debt instruments, are currently taxed 25 per cent on the dividend earned on liquid funds and 20 per cent for the dividend on debt funds. According to the Budget proposal, both would now be taxed at 30 per cent which may make these investment less attractive for corporations leading to a drop in overall AUMs, the report said.

However, fund managers do not think the industry AUM will see any meaningful impact as the advantages to investing in debt/liquid funds far outweigh the loss of the tax arbitrage that the corporations would have enjoyed.

Cap on Banks' Investments

“For corporations looking to park their short-term money supply, liquid funds are the best option as they can provide liquidity and higher returns than bank deposits in the short-term. A bank deposit would require banks to park their money for a period of at least six-months to one year,” said Mr Mahhendra Kumar Jajoo, Executive Director, Chief Investment Officer - Fixed Income, Pramerica Asset Managers.

RBI, in its policy review on May 3 for the fiscal 2011-12, reduced the investments of banks into liquid/debt funds to 10 per cent of their networth. Banks have been given time till October 2011to comply with the regulation. The ICRA report estimates that the banks investment stood at Rs 68,000 crore as on April 22, 2011, over 10 per cent of their networth.

Fund managers agree that the AUMs of fund houses will get affected, albeit only in the immediate short-term. The reduction in the AUM is expected at Rs 50, 000 – Rs. 60, 000 crore, but it's not a significant challenge say fund managers.

“A regulation of this sort from the central bank is always backed by a notification, which has still not been received by fund houses. So, the fineprint of how much will get affected is not known,” said a fund house official who did not wish to be named.

The industry AUM as on March 31, 2011 was Rs 5.92 lakh crore, a drop of 3.5 per cent from the previous year, of which the liquid/debt funds AUM was Rs 3.65 lakh crore.

These funds accounted for 61.7 per cent of the industry AUM as on March 31, 2011, down from 63.4 percent on March 31, 2010. This could further be eroded due to the regulatory reforms says the ICRA report.

COMMENT NOW