Less volatility for mutual funds

The Union Budget for the year 2008-09 has proposed to increase the short-term capital gains tax. The proposal is to increase the tax from 10 to 15 per cent. A short-term capital asset means a capital asset held by an assessee for not more than 12 months prior to its date of transfer. These assets would include equity and preference shares, debentures, government securities, units of UTI and other mutual funds, and zero coupon bonds.

In case these assets are held for more than 12 month immediately prior to transfer, it is a long-term capital asset. The budget proposal to increase the short-term capital gains tax to 15 per cent did not go down well with investors, and the benchmark Sensex dipped.

In addition, the Finance Minister has proposed changes in the securities transaction tax (STT), which will now be treated like any other deductible expenditure against business income. The Finance Minister has proposed that in case of sale of an option in securities, the levy of STT would be only on the option premium where the option is not exercised and the liability would be on the seller. The STT would be levied at the rate of 0.017 percent of the option premium and will be paid by the seller.
However, where the option is exercised, the levy would be on the settlement price and the liability would be on the buyer. STT on such a transaction would be levied at the rate of 0.125 percent of settlement price and would be paid by the purchaser.

In case of a sale of a future in securities, the STT would be levied at 0.017 percent and is to be paid by the seller. Meanwhile, there would be no changes in the present rates.

The Finance minister has also introduced the commodities transaction tax (CTT) on the lines of STT on futures and options. Service tax imposed on unit-linked insurance plans (ULIP), which compete with funds, would bring them at par and make them relatively more expensive, indirectly benefiting mutual funds.

The FM brought asset management services provided under ULIP at par with mutual funds. Higher tax will reduce the volatility of flows for mutual funds and attract long-term investors. Investors in equity funds now pay a short-term capital gains tax of 10 percent if redeemed within a year. It's bad news for capital markets but will encourage long-term investments in mutual funds.

Mutual funds pay service tax of 12.36 percent while selling securities, which ULIPs do not pay. Now, ULIPs, which distributors prefer to sell over relatively cheaper mutual funds as they offer higher commissions, will become more expensive, deterring investors. The change is also likely to have an adverse impact on ULIPs as it is possible that the additional tax costs will be passed on to the customer.