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Capital market, investors react positively to Sinha's measures for mutual funds

Muhammed Ash'ar Khan in New Delhi

If the BSE Sensex is taken as the indicator, Finance Minister Yashwant Sinha's budgetary proposal to exempt mutual funds from taxes has the wholehearted endorsement of the capital market and retail investors.

But not every one is happy with the measure. Some analysts say while mutual funds and investors stand to gain from the move, the government could end up the loser. In his budget speech, Yashwant Sinha, announced a package of incentives to restore investor confidence in the capital market. To revive the mutual funds industry in general and the Unit Trust of India in particular, he announced exemption from tax on all income received from UTI and other mutual funds.

The government also proposed to continue for three years the exemption from dividend tax the US-64 scheme and all open-ended equity oriented schemes of UTI and mutual funds with more than 50 per cent investment in equity. This made investment in UTI and mutual funds more attractive.

Thus all mutual funds are now exempted from dividend tax and income tax for a period of three years provided that more than 50 per cent of their portfolio was invested in equities. But some experts want the government to review the decision. They say corporates will try to raise money though mutual funds and avoid paying taxes. Vineet Aggarwal of Acumen Finance says, "This is an important way in which tax can be avoided.

For instance, ICICI can now route their entire funding through the ICICI mutual fund, which will then be able to borrow at 9 per cent or 10 per cent. Let's assume that ICICI mutual fund assures a return of about 10 per cent and invests it in ICICI itself, which then gives it a return of 13 per cent. So, at the end of the day, ICICI is pocketing that 3 percent and government is not making any tax out of it".

He says that the provision of tax exemption on mutual funds should be reviewed and looked at very carefully, because this would lead to a loss of revenue to the exchequer.

Others believe the measure will boost the capital market and mark the return of the small investor. This will infuse more funds into the market -- and the revenue generated will more than make up for what will be lost in tax collection. Gulbir Singh of Consortium Finance says, "The government will definitely lose out on some revenue on unit 64 and on the other mutual funds. But the mutual fund industry is at a very infant stage.

So, the revenue loss out of that is not going to be significant". He says that the finance minister has given a big boost to this industry. With the cut in the capital gains tax to 10 per cent and the abolition of payment of stamp duty on debt instruments traded through the depository route, the overall environment is very conducive for investments.

He asserts that there will be a shift from debt to equity, in the current scenario. There will be a large inflow of money into equity. A lot of investors will come in because of the tax benefits. Vineet Aggarwal says, "ICICI borrows a lot from the market and offers bonds at a rate of 13 or 14 percent.

Let's imagine a scenario where an ICICI mutual fund assures the investors a return of 12 percent. This 12 per cent will be tax free in the hands of investors, which will roughly translate to a taxable equivalent of 18 per cent, assuming the person is in the 33 per cent tax bracket - the highest tax bracket.

So, for a small investor, who is in the highest tax bracket, he is much better off earning 12 per cent from the ICICI mutual fund, which is tax free, than earning 13 per cent from ICICI in the form of a bond yield. In fact even if ICICI mutual fund offers 10 percent, he would still go for it because of the tax benefits".

Gulbir says, "You will definitely see a shift of the individual investor from directly investing in the stock markets towards the mutual fund route. And this is the practice worldwide. By this budget, Sinha has tried to integrate the Indian mutual fund industry with the rest of the world. We may not have one million direct investors in stock markets, but we will have 10 million investors routed through the mutual fund industry, as seen in the other countries".

The rationale behind the move according to experts is to revitalise the capital markets. The capital markets have been sleeping since the 1994 primary market boom. The measure has been taken to revive the primary and secondary markets and to make the climate conducive for disinvestment of PSUs.

The Indian mutual fund industry, apart from the US-64, is very small. Experts feel that now it will grow at a fast pace. There will be more private sector and corporate mutual funds. Vineet Aggarwal says, " In cases where mutual funds have less than 50 percent exposure in equities, mutual funds will have to pay 10 per cent dividend tax.

Still if investors put there money in these mutual funds they will be better off than investing directly in the bonds of financial institutions. On one hand government is trying to bring down interest rates and on the other hand, interest rates will automatically go up, because financial institutions will not be able to gather money at the rates they presently offer to the investors".

The step has been welcomed by investors and market operators. The BSE Sensex has been on the upswing since Budget day. The post budget bull run has brought about a surge in the net asset values of the major growth funds like the Kothari Pioneer's Infotech Fund, Birla Advantage Growth Fund and the Merrill Lynch's equity scheme. But it is too early to say whether the latest tax breaks for mutual funds will achieve their objective.

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