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Home > Business > Personal Finance

Bill seeks to include MF in securities

A N Shanbhag | October 18, 2003 15:03 IST

Securities Contracts (Regulation) Act (SCRA), 1956 defined 'Securities' under Section 2(h) to include ---

"i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable security of a like nature in or of any incorporated company or other body corporate;
ia) derivative;
ib) units or any other instrument issued by any collective investment scheme to the investors in such schemes; ii) Government securities;
iia) such other instruments as may be declared by the Central Government to be securities; and iii) rights or interest in securities."

Unfortunately, units of UTI or MFs were not included in the above definition. The point 'ib' relates to chit funds, time-sharing enterprises etc., and not units of UTI or MFs, notified under Section 10(23D).

Moreover, scrips, stocks, bonds, debentures, debenture stock should necessarily be marketable.

Units of UTI/MFs of open-ended schemes are not listed because the repurchase facility is available in any case. This implies that even if these could be construed as securities by any stretch of imagination, the fact that they are not listed (= not marketable) will be the main impediment.

Section 112 specifies that the tax on long-term capital gains (arrived at after indexation) must be taken as a separate block and charged to tax at 20 per cent.

The second proviso of this section gives the option to the assessee of paying tax at 10 per cent on any income (= sale proceeds - cost of acquisition and improvements without indexation) arising from the transfer of a long-term capital asset, being listed securities or unit.

Note that the word 'unit' is mentioned separately thereby implying that unit, even if listed, is not a 'security'. This is the reason why when shares of a private limited company are transferred or sold, the resulting capital gain, if long-term, attracts tax at flat rate of 20 per cent after indexation.

The option of 10 per cent tax without indexation is not available to such shares. This is a well recognised and accepted fact. Now the main difficulty.

If units are not securities, SEBI has no jurisdiction over MFs. Section 55(2aa) states, that where, by virtue of holding a capital asset, being a share or any other security, within the meaning of Section 2(h) of SCRA, the assessee --- (A) becomes entitled to subscribe to any additional financial asset (= rights); or (B) is allotted any additional financial asset without any payment (= bonus) then the cost of acquisition is the amount actually paid for acquiring the rights or purchase of the rights from someone who renounces his rights in favour of the assessee.

In the case of bonus shares, the cost of acquisition will be nil. Simply put, the cost of acquisition of bonus securities will be nil and the rights (or purchase of the right to rights) will be the actual cost of the securities. Units were not securities.

Therefore, the cost of bonus was not nil. And the cost of rights was not the price paid. Obviously, the only alternative was to apply the old principle of carrying forward the cost of acquisition on the basis of weighted average in the case of units.

In spite of everything discussed above, in the case of PCS Industries Ltd. vs Securities and Exchange Board of India, 35SCL939 (Securities Appellate Tribunal, Mumbai) it was held that units are securities.

The public offer of units of a mutual funds is an 'issue' in terms of Rule 2(d) of the Securities and Exchange Board of India (Registrars to an Issue and Share Transfer Agent) Rules, 1993.

Though recently the MoF as well as SEBI clarified and also the SAT, as mentioned above, ruled that the MF units are securities, these pronouncements required to be codified in the law. In other words, the SCRA requires an urgent amendment.

Thankfully, a bill has been introduced in Parliament which proposes to expand the definition of securities to include units of MFs. If the bill is passed, it will eliminate all the ambiguities over the legal status of MF units and also clarify SEBI's jurisdiction over MFs.

Yes, there is always an uncertainty about the bill getting through Parliament because of vested interests. If the fear of such interests scuttling the right from wrong was not looming over, the recent Supreme Court judgment requiring, and rightly so, a ratification by the Parliament for disinvestments of PSU scrips would not have created a scare.

Now, in the case of those units which are issued in a dematerialised form and listed and traded on exchanges similar to any other security, all the erstwhile problems will stand eliminated. If the bill does get through, the MF industry will flourish and there will be a scramble for getting MF schemes listed on exchanges.

And finally, if the units do indeed start being traded as securities, MFs do not have to apply Tax Deduction at Source on brokerage. I hope I am right.

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