Tax tweaks on equity fund of funds

Equity FoFs — three of them — are now treated as equity mutual funds for taxation

Equity fund of funds (FoFs) have been gaining investors’ attention in recent times, thanks to a taxation tweak announced in Budget 2019. The Budget proposed a concessional rate of short-term capital gains (STCG) tax to certain equity-oriented FoFs.

FoFs are mutual fund schemes that invest in other mutual funds. While a normal mutual fund scheme holds a portfolio that comprises various stocks, bonds and other assets, an FoF simply invests in other mutual funds. FoFs are suitable for small investors who want to get better exposure with fewer risks, compared with directly investing in individual funds.

Currently, 71 FoFs are available in India, managing around ₹7,850 crore of AUM (assets under management) (as of July 2019). Of these, 31 invest in domestic mutual funds including equity and debt funds, while 11 invest in gold exchange-traded funds (ETFs). There are 29 FoFs that invest predominantly in foreign mutual funds.

Normally, all FoFs are treated as non-equity funds for taxation purpose. In the case of non-equity funds, a holding period of 36 months or more is regarded as long-term, wherein the long-term capital gain (LTCG) tax is levied at 20 per cent with indexation on the gain. A holding period of less than 36 months is defined as short-term, and attracts STCG tax, charged as per the investor’s tax slab.

Budget 2018 brought in taxation of LTCG of FoFs which invest more than 90 per cent in units of equity ETFs, on par with equity funds. Budget 2019 extended the treatment to STCG as well.

So, equity FoFs that qualify for the above criteria are now treated as equity funds for taxation purpose. Under equity funds, a holding period of 12 months or more is regarded as long-term, wherein LTCG in excess of ₹1 lakh is taxable at the rate of 10 per cent, without the benefit of indexation. There is a 15 per cent tax on short-term gains from equity funds, if the units are redeemed before 12 months.

Among the FoFs investing in domestic funds, five allocate more than 90 per cent of their corpus in equity- oriented funds and ETFs.

However, only three FoFs — ICICI Prudential Bharat 22 FoF, Reliance Junior BeES FoF and ICICI Pru Passive Strategy Fund — invest solely in equity ETFs.

Launched in June 2018, ICICI Pru Bharat 22 FoF allocates more than 95 per cent of its corpus in Bharat 22 ETF. Bharat 22 ETF is the equity ETF set up for disinvestment of Central public sector enterprises (CPSE). It tracks the benchmark S&P BSE Bharat 22 TRI Index.

Reliance Junior BeES FoF was launched in March 2019. It allocates its corpus to Reliance ETF Junior BeES which tracks the Nifty Next 50 TRI. The index represents the balance 50 companies from NIFTY 100 after excluding the NIFTY 50 companies.

Post the re-categorisation of mutual funds in June 2018, ICICI Pru Passive Strategy Fund has invested primarily in equity ETFs. Currently, it invests in three ETFs — ICICI Pru Nifty ETF, ICICI Pru Nifty Low Vol 30 ETF and ICICI Pru Midcap Select ETF.

The above mentioned three equity FoFs are eligible for both the LTCG and STCG tax treatments similar to that of equity funds. However, there has been a confusion over STCG as Budget 2019 mentioned that the concessional rate in STCG tax is available if these FoFs invest in funds set up for the disinvestment of a CPSE. According to sources, the industry is in talks with the government to rectify this anamoly.

Systematic transaction

Investors require demat and brokers’ trading accounts to invest in ETFs. Further, asset management companies do not allow any systematic investment routes such as SIP, STP or SWP while investing in ETFs.

These FoFs (including Motilal Oswal Nasdaq 100 FOF, which is not an equity FoF, and gold FoFs) enable investors to participate in the underlying ETFs without a demat or a broker’s account, and allow a systematic route to invest.

While liquidity has been a big constraint in exchanges when transacting in ETFs, these FoFs come to the rescue and eliminate such hurdles as investors are allowed to buy and sell FoFs directly from the fund house.

Investors should note that FoFs incur a double layer of costs — there is an added expense pertaining to the underlying funds, apart from their own expenses.

Published on August 11, 2019

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