Mutual fund sector is finding itself at back foot with the Union Budget proposing an increased flat rate of tax on debt funds at 20% while increasing the tenure to claim long-term tax gains from 12 months to 36 months.
The industry executives say that the measures may have 'cascading' impact especially when over 70% of the assets under management (AUM) are in the debt category. On top of it, the fixed maturity plans or FMPs - the most impacted, which offer attractive rate of returns to investors in short term category, alone make up nearly one fifth of the total debt assets.
It's not only the higher taxes on these products, which can force investors shift to other comparable investment avenues, a cause of concerns to industry's officials. What more are they worried about is the fact that the new norms come with a retrospective taxation effects.
"Though the Finance Minister said that it is applicable from April, 2015 but the assessment year is 2015-16. This means such investments will be taxed from the current ongoing financial year itself. That's an issue," said executive vice president (EVP) of large-sized fund house.
Others in the industry agree. According to them, investors who got in such products so far this financial year will have to pay taxes of 20-30%.
Niranjan Risbood, director (fund research) at Morningstar India, says, "The money which was being invested with a time frame of 1-3 years would get impacted with some redemptions seen from the open-ended funds before this new tax rule comes into effect." He added that AMCs is likely to launch more of longer term (3 years plus) FMPs or capital protected plans to cater to the new tax regime.
Executives, for whom taxation in debt funds came out of the blues, told Business Standard that there will fewer launches of FMPs going ahead and impetus would be to come up with funds with longer tenures provided investors have an appetite for such products.
Currently, around 75% of the assets in FMP category have one year investment horizon. It is interesting to note that in June, assets of FMPs have touched a record high of Rs 1.74 lakh crore, a rise of 12% or Rs 18,600 crore.
According to sector officials, incremental flows in FMPs would be thing of the past. "I do not think investors would prefer such products with a three year lock-in period. For them, banks' fixed deposits might be better options now," said chief marketing officer (CMO) of one of the top fund houses in India.
Further, the impact is not going to be restricted only to FMPs when it comes to inflows of money. Short-term debt funds which see large companies park money to earn attractive yield could see lesser inflows from corporates and institutional money.
"The corporate money which would probably get impacted adversely will be that with a time horizon of more than one year. This used to get invested into FMPs or short term funds. Some part of such money could move to other investment avenues like bank deposits," adds Risbood.
Fund managers echo the sentiments. According to them, they do not see much of a fall in flows of institutional money which get invested with a horizon of less than a year - in liquid and liquid plus funds. "But in funds with tenure of over a year, big money flows will see an impact. I think, bankers' lobby has managed to snatch this benefit from us," says chief executive officer (CEO) of a mid-sized fund house.
As on 30 June, sector's total AUM stood at Rs 9.75 lakh crore.