Mutual funds industry gets the thumbs up

Investors may turn to growth schemes of income funds to avoid tax incidence

Highlights

• Income by way of dividends from mutual funds have been made taxable in the hands of the investors. Such income will be subject to TDS at the rate of 10%.
• Tax payable by mutual funds on distribution of dividend has been completed removed, from the previous 10%.

• Income received during the financial year 2002-2003 by unit holders of equity funds will be taxed only at 10% as at present.
• Companies distributing dividends will be entitled to claim a deduction for the amount.
• No announcement regarding extending the exemption from dividend distribution tax, for open-ended equity funds, set to expire in April 2002.

• Legislative changes to be made in UTI Act, which will bring it on par with other mutual funds. Seeks to balance balance investors' interest while ensuring systemic safety.

• Indian mutual funds will be allowed to invest in rated securities in countries with fully convertible currencies, within the existing limits. Earlier such investment was only permitted in ADR/GDRs issued by Indian companies in overseas markets.

• Rates of personal taxation remain the same. Existing 2% surcharge removed and a new surcharge of 5% levied.

• Rebate at the existing rate of 20% only to persons having taxable income upto Rs 1,50,000. Persons having taxable income between Rs 1,50,000 and Rs 5 lakhs will get a rebate of only 10% of the amount invested, and no rebate will be allowed where taxable income exceeds Rs 5 lakhs. The special rebate of 30% for persons having taxable salary income upto Rs 1 lakh will, however, continue.

• Interest rates on small savings and RBI Relief Bonds reduced by 0.5%.

• The new pension scheme for new recruits will be announced and implemented by 1 June 2002.

• Measures to improve debt markets:

1. Primary issuance of government securities is now being facilitated by an electronic Negotiated Dealing System (NDS) and efficiency of trading in government securities is being brought about by the new Clearing Corporation of India Limited (CCIL).
2. Announcement of introduce a new Government Securities Bill to replace the old Public Debt Act 1949, within this Parliament Session.

• Measures to improve equity markets:

1. Demutualisation and corporatisation of stock exchanges is expected to be completed during this year.
2. Changes to be made in the Sebi Act 1992.
3. Proposal to strengthen regulation in accounting standards and effectiveness of auditors.
4. FIIs can invest in a company under the portfolio investment route, beyond 24% of the paid up capital of the company.

The Union Budget 2002-2003 has abolished the 10% distribution tax paid by the mutual funds. At the same time, individuals receiving dividends from mutual funds will be taxed at 10%. This comes at a time when the taxpayer is being hit from all quarters. Introduction of slabs to avail tax rebate, no change in personal income tax levels, a surcharge of 5% and now TDS of 10% on income received as dividends from mutual funds.

The reason cited for doing so by the finance minister while presenting the budget was there is an inherent inequity in the present system which allows persons in the high income groups to be taxed at much lower rates than the rates applicable to them.

The reduction in administered interest rates of small saving schemes by 50 basis points will be good for the mutual funds. The reduction will see investors shifting from the government saving schemes to mutual funds, which will now be an attractive proposition. Last fiscal, Sinha had cut small saving interest rates by 150 basis points. This move indirectly benefited mutual funds by channelising the flow of funds from banking sector to mutual funds. Comments Suraj Kaeley, Vice President-Sales & Marketing, Templeton Mutual Fund, "The budget has made the dividend income from mutual funds, taxable in the hands of the investors. This has been bit of a dampener. The sweetener has gone but the cake is still there. With the overall interest rates of other investments coming down, mutual funds will continue to be one of the key investment avenues. The investors will definitely realise that mutual funds are the right place as far as the management of risk is concerned."

Though a shift is seen to mutual funds, it will be towards the growth schemes of income funds. Most income funds and monthly income plans offers monthly, quarterly, half-yearly and annual dividend options. Given the current situation where an individual has to cough up 31.5%, it makes sense to switch to the growth option of the scheme to avoid tax incidence. This would mean that the dividend options of most of the schemes would become redundant.

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