SEBI SENDS PROPOSAL TO FINMIN

India Inc may lose tax sops on MF investments

CAPITAL markets regulator Securities and Exchange Board of India (Sebi) wants the government to scrap tax benefits for corporates investing in mutual funds (MFs), a proposal, if accepted by the government, could deal a body blow to local asset management companies and other firms. 

    The regulator has also proposed to the government that the securities transaction tax, or STT, which is levied on buying or selling of stocks and on derivatives trade, should be cut by one-third and that a uniform stamp duty be levied and collected by a central agency. These proposals have been forwarded to the finance ministry, in the run-up to the Budget, said a person with the knowledge of the proposal. 
    The letter to the finance ministry says, "Tax benefits to corporates investing in schemes of mutual funds may be withdrawn." 
    It is not just the capital markets watchdog that is uncomfortable with MF industry's unhealthy dependence on short-term funds from corporates. Though this helps fund houses grow their assets and boost valuations, policymakers are worried about the systemic implications of any swift outflow of such institutional funds that could hobble some of the fund houses. This was evident during the secondhalf of 2008, when the Reserve Bank of India (RBI) had to keep liquidity support open to help MFs meet their redemption obligations. 
    RBI has also been unhappy at the way banks have been parking their surplus with MFs, which in turn finds its way back to banks. The central bank has nudged banks to restrict their investments in MFs. 
    Any move, either to do away with the tax benefits or to tweak the tax rates, could hurt the local MF industry whose growth is linked to the flow of funds from corporates. Over 50% of the money that Indian MFs attract for their debt schemes comes from corporate treasuries and banks. According to latest data, the assets under management of the Indian MF industry are a little under Rs 7-lakh crore. 
UNDER THREAT 
Big Loss 
Sebi's proposal aims to end tax arbitrage by corporates. While income from treasury ops is subject to corporate tax of 33.99%, treasury investments in debt funds attract a dividend distribution tax of 22.66% 
Retail Therapy 
Sebi seeks to develop MFs as a vehicle for retail investors to take exposure in the securities market 
Fund Flow 
Currently, more than half of the inflows to MFs' debt schemes come from corporate treasuries and banks Sebi wants govt to cut STT by a third 
SEBI'S proposal is aimed at putting an end to the rampant misuse of debt schemes of MFs by corporates, who park short-term corporate treasury funds to enjoy a tax arbitrage. While income from their treasury operations attract the corporate tax rate of 33.99% (including surcharge and education cess), treasury investments in debt funds attract a dividend distribution tax (DDT) of only 22.66%. 
    "If the tax benefit is removed, it will discourage corporates from using mutual funds as a treasury instrument... as we want to develop mutual funds as a vehicle for retail investors to take exposure in the securities market," said a Sebi official. Recently, RBI had told banks to go slow on their MF investments. In the last fortnight of December 2009, banks withdrew more than Rs 1- lakh crore from MFs. RBI deputy governor Shyamala Gopinath too had expressed her concerns about tax arbitrage through mutual fund investments. "Mutual funds' fixed-income products enjoy certain tax exemptions not available to banks. But this is outside the regulatory purview. However, if these policies introduce any vulnerability in the financial system, there is a need to address this through appropriate macroprudential and microprudential regulations," Ms Gopinath said at a Fixed Income and Money Market Dealers Association (FIMMDA) meet. 
    Sebi has also asked the government to drastically reduce the securities transaction tax (STT) on equity transactions, as it increases the transaction cost. The regulator has recommended that STT should be slashed by one-third, as the rate has effectively tripled with the withdrawal of STT as a rebate under Section 88E in the last Budget. 
    Besides proposing a uniform stamp duty that will levied and collected by a central agency and shared among states based on an agreed formula, Sebi has recommended a goods and services tax (GST)-type concept for stamp duty collection on securities trades. Market players say that there are several anomalies in the stamp duty, as it is levied by states with each levying different rates for different securities instruments. 
    Transaction costs in India are one of the highest in the world, with government levies, such as stamp duty and STT, accounting for almost 75% of the cost.Sebi also wants Indian Depository Receipts(IDRs) — instruments through which Indian investors can invest in equity shares of foreign companies — to be treated as securities for tax purposes. It has also recommend to the government that IDRs should not be taxed on transfer.