We are just a few days away from the upcoming Union Budget 2023, and like every year, expectations from the ₹40-lakh crore mutual fund (MF) industry and lakhs of investors are running high. While there is a long list of demands, most relevant expectations centre around the need to bring parity in tax treatment for investments in different financial sectors, ways to mitigate hardship to retail and NRI taxpayers. Here is a quick look.

Need for parity

There is disparity between tax treatment on switching of investment within a MF scheme and within a ULIP of insurance companies, although both invest in securities, and are investment products. Switching of investment in units within the same MF scheme from growth option to dividend option (or vice-versa), and/or from regular plan to direct plan (or vice-versa) is considered a “transfer” and is liable to capital gains tax, even though the amount invested remains in the MF scheme. The same done in case of ULIPs does not attract such tax. Thus, intra-scheme switches should be made exempt from payment of capital gains tax.

Similarly, there is an imminent need for uniform tax treatment on capital gains from MF investments and ULIPs of insurance companies. Currently, Long-Term Capital Gains (LTCG) arising out of the sale of listed equity shares and units of equity-oriented MF schemes are taxed at the rate of 10 per cent, if the LTCG exceed ₹1 lakh in a financial year. However, the proceeds from ULIPs (including early surrender / partial withdrawals), are exempted from income tax under Section 10(10D), if the sum assured in a life insurance policy is at least 10 times the annual premium and withdrawn after a lock-in of five years. There is a clear case of tax arbitrage, whereby ULIPs are placed at an advantageous position vis-à-vis MFs. Thus, a level-playing field among similar products and players in the financial industry is required.

There is also parity needed in holding period for capital gains tax purposes for direct investment in listed debt instruments and investment in such listed debt instruments through debt-oriented MF schemes. The holding period for direct investment in a listed debenture to be treated as long-term investment for capital gain tax purposes is 12 months. But if the same investment is made through a debt-oriented MF scheme, the period of holding is higher at 36 months to be regarded as long-term investment for capital gain tax purposes. Thus, there is a need for harmonising the tax treatment on such investments.

Relief for MF investors

MF industry body AMFI has sought an increase in the threshold limit of withholding tax (TDS) on income distribution by MF scheme. Presently as per provisions, TDS is applicable on income distribution by MF scheme to resident investors, where the aggregate of the amounts of such income distribution exceeds ₹5,000. Hence, the Budget can consider hiking this threshold limit. It is pertinent to mention here that the threshold limit for TDS on interest on bank FD was raised from ₹10,000 to ₹40,000.

Some hardships for NRI investors can also be mitigated. MFs are required to deduct tax at source from amount paid/credited to NRI investors — (i) u/sec. 111A & 112A from the capital gains arising upon redemption of units; and (ii) u/sec, 56 on income distribution (dividends) paid/credited in respect of mutual units. In addition to TDS, surcharge needs to be deducted at specified rates based on total income slabs. There is no way for mutual funds to know the income slab of the NRI investor, so as to determine the appropriate rate of Surcharge on the TDS to be applied at the time of making payment of dividend or redemption proceeds. An MF would be regarded as an ‘assessee in default’ for any shortfall in TDS. The Budget can prescribe a uniform rate of surcharge @10 per cent on TDS in respect of dividend from MF units to NRIs as well as the capital gains arising upon redemption of MF units in respect of NRIs, instead of slab-wise rate of surcharge specified. Apart from these, there are proposals to reduce tax/TDS rate for NRIs on STCG from debt schemes from 30 per cent to 15 per cent, allow indexation benefits to non-resident investors for investment in debt MFs etc.

The MF industry also has requested for introduction of Debt Linked Savings Scheme (DLSS) to help deepen the Indian bond market. Also, there is a request to allow MFs to be allowed to launch pension-oriented MF schemes (MFLRS) with uniform tax treatment as National Pension System (NPS).

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