Budget 2023: MFs seek LTCG exemption for longer-term equity investments

Industry says exemption for those staying invested for over three years will help channelise flows into financial assets

The mutual fund industry has sought a tax exemption for equity investors in the upcoming Budget to "encourage long-term investment". 

"It is requested that listed equity shares or units of equity-oriented fund schemes be exempted from [long-term] capital gains tax (LTCG) if the equity shares or mutual funds units are held for at least three years," the industry stated in its wishlist for Budget 2023.

Justifying the proposal, industry lobby the Association of Mutual Funds in India (Amfi) said the 10 per cent LTCG tax on equity schemes is at times higher than the effective tax on debt investments post indexation benefits.

At present, the gains from equity investments (held for more than one year) are taxed at a flat rate of 10 per cent if the profit exceeds Rs 100,000 in a financial year. In the case of debt funds, the gains are taxed at the investors' slab rate but those staying invested for more than three years get indexation benefits (the value of investment is adjusted for inflation to bring down the tax).

"(The proposal) if considered, will encourage long-term investments in equities and will help channelise more household savings into the equity markets, thus helping the Indian economy," Amfi said in a note.

Fund houses have also sought preferential tax treatment for gold exchange-traded funds (ETFs) to "encourage retail investors to invest in gold through the mutual fund route rather than buying physical gold". They have proposed an LTCG tax of 10 per cent on profits instead of 20 per cent with indexation benefits, and have also sought reduction in holding period for LTCG to one year from three.

"(The proposal) is in line with the government’s agenda to discourage savings and investments in physical gold/jewellery and boost the financialisation of gold holdings," Amfi said.

At present, the tax rate is the same for every gold investment avenue.

The industry has also called for parity in taxation of equity funds and fund of funds (FoFs) investing in such schemes. At present, schemes that invest at least 65 per cent in equities are taxed as equity-oriented schemes. However, FoFs investing in such schemes often come under the ambit of 'non-equity' taxation. This is because only FoFs that have invested in equity funds with over 90 per cent allocation to equities qualify for equity taxation.

"The tax treatment should be the same in both the cases, as the underlying portfolio of investments includes domestic equities only. This will ensure that the intent of the law is not sacrificed," Amfi said.

Beyond these, the industry has sought exemption for itself from the newly added section 194R in the Income Tax Act. Explaining the rationale, Amfi said if an investee company defaults, the law would require the fund house to pay TDS on behalf of that investee company, leading to more losses for investors. The industry has also called for amendments to section 43B to align the time limit for filing tax audit reports and returns.

Apart from these proposals, most other requests made by Amfi are the same as last year. For example, it has reiterated its long-standing request to bring parity in tax treatment of mutual funds and unit-linked insurance plan (ULIP).

"There is still a clear case of tax arbitrage, whereby ULIPs are not only placed at an advantageous position vis-à-vis mutual fund schemes, but there is also a significant revenue leakage on capital gains from ULIPs, especially from HNI segment," Amfi stated in its wishlist for Budget 2023.

The other long-pending demand that has re-appeared this year is uniformity in taxation on listed debt securities and debt mutual funds. The holding period for long-term taxation is 12 months for listed debt paper and 36 months for debt funds. The industry has requested the minimum holding period to be brought down to 12 months for debt funds also.

Other key proposals:

• Tax benefits, nod for new products in Amfi's wishlist

• Bring uniformity in tax treatment of intra-scheme switching in mutual funds and ULIPs

• Allow MFs to launch pension-oriented schemes with same tax treatment as NPS

• Extend indexation benefits to non-resident investors

• Allow debt linked savings scheme to help deepen the Indian bond market

• Increase threshold limit of withholding tax on income distribution by MF schemes

• Rationalise stamp duty on ETFs

• Allow government companies to invest in private sector mutual funds