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Jaitley tinkers but retains budget devil

New Delhi, July 25: The Narendra Modi government today cut the ground beneath investors in debt mutual funds by refusing to soften the rigours of a new tax regime that effectively skewers the gains they made on an investment strategy devised last year when stock markets around the world were in turmoil.

In Budget 2014, finance minister Arun Jaitley had tweaked Section 112 of the Income Tax Act, effectively raising the capital gains tax on investments in debt mutual funds — which became a very attractive investment avenue when equities were being clobbered last year — to 20 per cent from 10 per cent.

Worse, the holding tenure for debt mutual units was extended to 36 months from 12 months. And the rule change came into effect from April 1 this year.

The sudden and dramatic change in the rules of the game meant that investors who pumped their surplus money into debt funds with a 12-month investment horizon were suddenly asked to stretch it to three years if they wanted to qualify for a capital gains tax of 20 per cent.

If they sold before that period, they would face the unsettling prospect of having their capital gains added to their income and taxed at the regular tax rate. Anyone with a taxable income of over Rs 10 lakh a year has to pay tax at 30 per cent.

Jaitley today said that bowing to the clamour from parliamentarians and industry representatives, he had decided to remove the “retrospective” element by re-setting the date for the rule change from April 1 to July 10 — the day he presented the budget.

The modification doesn’t address the basic issue: investors who parked surplus money in debt mutual funds any time after July 12, 2013, will now have to face a tax sledgehammer.

If they sell the units after July 10 this year — sticking to the 12-month horizon they had when they made the investment — they will have to cough up 30 per cent in most cases.

The only way to save themselves from the “wrecking ball” is to extend their investment horizon to 36 months —which means they will not be able to sell anytime before July 11, 2016 — if they want to cap their tax at 20 per cent which comes with the benefit of indexation.

Indexation is a technique designed to adjust income payment by means of a price index in order to maintain the purchasing power of the taxpayer after taking into account rates of inflation.

Most small businessmen, medium entities and private clubs — which are facing a massive liquidity crunch —were hoping for a “grandfathering” option that would have protected investments made a year ago from the crippling effects of the new levy.

“Grandfathering” is a provision in which an old rule continues to apply to some existing situations while the new rule applies to all future cases.

“The tax modification announced today should have been applicable to even those investors who had invested before July 10 when the tax regime was different,” said the Sundaram Mutual Fund deputy CEO, Sunil Subramaniam.

“This is only a marginal relief. Fund flows to our industry will drastically come down. Earlier, Sebi (market watchdog Securities and Exchange Board of India) hit us hard by doing away with entry loads and now Arun Jaitley has followed,” said a top official with a leading fund house.

The government — which set itself a daunting fiscal deficit target of 4.1 per cent this year — is under pressure to ratchet up its tax collections and isn’t, therefore, budging from its position on the contentious issue.

“People have the option of either withdrawing from those schemes or the mutual funds have the option of recalibrating and redesigning their schemes in the new taxation regime… the redemption of units is a fait accompli and nothing can be done about it,” revenue secretary Shaktikanta Das told a television channel.

In May last year, the US Federal Reserve announced its intention to wind down its $80-billion monthly bond buying programme, sending shock waves through equity markets around the world. Indian stocks also wilted and the Sensex plunged to 20,000 —prompting investors to park money in debt mutual fund units.

Since then, the sensex has surged almost 30 per cent and currently hovers around 26,000.

The government is clearly sending out a signal that it doesn’t want corporates and other entities to shovel money into the mutual funds and hog the tax breaks intended for individual investors. The mutual fund industry’s assets under management have swelled to Rs 9.85 lakh crore, largely because of corporate entities rather than individual investors.

“The three-year lock in and tax at 20 per cent with inflation indexation is not bad… we have done a number of case studies with this new rate and find that with inflation ranging between 7 and 9 per cent annually, one actually ends up paying less tax in the new dispensation rather than the old set up of 10 per cent tax without indexation at the end of one year,” said Anish Thakkar, partner with consultancy Ernst & Young.