Budget 2017: Expectations of Equity & Mutual Fund investors…

What are the key expectations of equity and mutual fund investors in India from the Union Budget? It could be a mixed bag for equity and mutual fund investors. The government has indirectly expressed its plans to tax equity more aggressively. At the same time, mutual funds as a long term wealth creation may be incentivized. Here are the key expectations…

Some changes in capital gains taxation may be a two-way street…

This has been on the anvil for a fairly long time. To begin with, the government may look to change the definition of long term capital gains (LTCG) from 1 year to 3 years in case of equities. This will put equities at par with other asset classes. Secondly, the government may look to raise the rate of tax on short term capital gains (STCG) to 20% from the current level of 15%. This will reduce the current distortion wherein interest on debt is being taxed at twice the rate of short term capital gains. Additionally, one can expect closer scrutiny of write-offs that tax payers have been using to reduce their tax outflow. The SEBI and the CBDT have already begun this exercise and most equity exemptions that you claim are likely to come under the scanner.

Higher exemption for ELSS under Section 80C…

This could be a major positive for mutual fund investors. Equity Linked Savings Schemes are equity mutual funds which qualify for exemption u/s 80C but also entail a lock in period of 3 years. Currently, ELSS investments are covered under the overall limit of Rs.150,000/- under section 80C. This limit is shared by a number of asset classes like insurance premiums, PF contribution, NSC  investments, tuition fees, principal on home loans, long term FDs etc. This leaves very little scope for any tax saving under ELSS. The government may, therefore choose to raise the exemption limit under Section 80C to Rs.200,000. Alternatively, the budget may also choose to give a special incentive for ELSS, which may be on the lines of the RGESS. Either ways, equity funds could benefit.

Aligning tax rates on equity and debt mutual funds…

Currently, there is a strong demand to align the tax structures of equity and debt mutual funds since the investors in both the instruments could be part of the same individual’s asset allocation. Currently, equity mutual funds have to be held for only 1 year to qualify for LTCG while debt funds have to be held for 3 years. Additionally, equity funds enjoy concessional rates of STCG and exemption from LTCG. One of the expectations of this Budget is that the rates of taxes on debt funds could be reduced if not brought down to the levels of equity funds. That will, at least, encourage greater participation of retail investors in debt funds, which is currently a preserve of HNIs and corporates. This will also encourage more retail investors to go in for scientific financial planning and adopt a long term approach to achieving their life-time goals with a judicious mix of debt and equity.

Encouraging the Fund of Funds (FOF) concept in India…

One of the reasons the Fund of Funds (FOF) idea has not taken off in India in a big way is that the tax treatment is unfavourable. A fund of funds is a hybrid product which creates a portfolio by combing other mutual funds. Today in India, even if you create a FOF by combining equity funds, the FOF will still be classified as a debt fund for taxation purposes. That means, it will be LTCG only if it is held for a period of more than 3 years. Also, STCG will attract peak rates of tax and LTCG will also attract tax at concessional rates. In most other developed markets, FOF is a multi-billion dollar industry and it has emerged as a major boon for retail investors. However, in India due to the unfavourable tax treatment, this product has not taken off in a big way. The government may look to reverse this anomaly in case of FOFs.

Big boost for equities from rural spending…

The equity markets are expecting a big boost from a spurt in rural spending. Firstly, the government has anyways decided to compensate the rural population for the pain of demonetization. One of the ways will be invest more in rural infrastructure and also spend more on rural welfare schemes. This will result in a substantial demand expansion in rural areas and will directly benefit sectors like consumer durables, FMCG products, two wheelers, tractors, seeds and agrochemicals etc. Normally, a spurt in rural demand combined with better agricultural performance has a multiplier effect on the overall economic growth. That could be big macro boost for the equity markets.

It could be a mixed bag for equity markets. We believe that the broad theme of the budget could be to encourage more of retail participation into equities via the mutual funds route. At the same time, the government may also look to make equities contribute more towards the tax kitty. The focus will be on putting a higher levy on capital gains, ensuring better compliance and reducing leakage in tax collections.

You can ask us your stock related questions with #AskReligareOnMarkets via our Twitter channel @religareonline.


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