The asset under management (AUM) of debt mutual funds in the Indian mutual fund industry stands at Rs 7.60 lakh crore, which constitutes roughly 80 per cent of the industry’s total assets. A vast majority of the debt fund schemes are short term in nature, bearing maturities of around one year or less. The other crude fact is that these short-term debt schemes, a majority of them fixed maturity plans (FMPs), are products where companies and high net worth individuals park their funds because of a favourable tax regime compared with other available debt instruments of similar tenure.

Till the other day, FMPs, which are of duration of a little over a year, used to attract long-term capital gains tax at 10 per cent without indexation and 20 per cent with indexation compared with the maximum marginal rate of taxation in case of bank fixed deposits irrespective of the duration, and 20 per cent long-term capital gains tax with indexation in the case of other debt instruments such as bonds in which case long-term is considered as more than three years. If such FMPs are held for a little over one year spanning three financial years, e.g, invested at the end of March 2013 (FY2012-13) and maturing in early April 2014 (FY2014-15), one could have the benefit of double indexation, thereby reducing the tax liability to virtually nil.

This was the tax arbitrage that benefited companies and high net worth individuals (HNIs) riding on the bandwagon of mutual funds, which were basically meant for small investors to appreciate their investment values over long term. Even if FMPs had investments from small investors in small measures, they amounted to misaligning their expectations from debt-oriented mutual fund schemes by splitting the tenures. This was also not in consonance with the financial planning regimen of investing to achieve long-term goals by judiciously allocating investments across asset classes like equity and debt. The budget for 2014-15 addressed the above anomaly by treating all debt classes alike.

Though the measures announced in the financial bill are effective from April 1 of the financial year once they are passed in the finance Act, the measure of over three-year duration and 20 per cent long-term capital gain treatment for debt funds has been made effective from July 11. This means all such funds redeemed between April 1 and July 10 will be eligible for over one-year duration and 10 per cent long-term capital gains treatment.

This is a huge relief, as it would not amount to retrospective taxation. As regards the impact of this proposal on the distributor community, there lies huge potential for attracting investors’ assets to long-term debt products. Such long-term managed schemes are likely to offer better margins to the distributors than what was permissible in FMPs. There are new vistas to be explored by apportioning investors’ funds across asset classes in a true advisory capacity. Short-term blips apart, such enhancement of skills would result in trust building with the financial sector consumers and would result in better remuneration in the long run.

Source : (By Mudholkar, he is the vice-chairman and chief executive officer of Financial Planning Standards Board India)