Debt MF changes negative for MFs, marginally positive for life insurers: CLSA

The long-term tax benefit for Debt Mutual Funds (MFs), if they invested less than 35 percent of their assets in equities, will be stripped off. Such mutual funds will now attract short-term capital gains tax, according to an amendment in the Finance Bill of 2023 passed in the Lok Sabha on March 24.

The benefit of indexation for long-term capital gains on such debt mutual funds will not be available for investments made on or after April 1, 2023, and they will be taxed at the income tax rate applicable to the investor.

Earlier, gains on investments in debt MFs for more than three years were subject to a long-term capital gains tax rate of 20 percent post-indexation. Indexation factors in inflation, which helps to lower taxes significantly.

With the amendments, there will be no tax arbitrage left across debt instruments, whether they are bank deposits, debt MFs or life insurance savings products. Some experts said hybrid funds could now become more attractive.

Here are CLSA’s views on the changes:

For MFs

This is a negative for mutual funds with non-liquid debt assets under management of about Rs 8 lakh crore (19 percent of AUMs) as the relative attractiveness due to tax arbitrage goes away, according to CLSA.

“This is negative for MFs–Debt (ex-liquid) contributes 19 percent of AUMs and 11-14 percent of revenues,” CLSA said, adding that liquid MFs of Rs 6.6 lakh crore will not be impacted materially as they are anyway a short-term product.

However, DP Singh of SBI Mutual Fund told CNBC-TV18 there will still be a 100-150 basis point gap between MF and deposit yields. The corporate share in debt funds is more than 50 percent while the share of high net worth individuals will be about 20-25 percent. Singh said the realisation of debt will be impacted.

Also read: A tax googly that debt fund investors in India didn’t see coming

Shares of Aditya Birla Sun Life AMC, HDFC Asset Management Company and UTI Asset Management Company slumped 4-5 percent on the BSE.

For insurers

The status quo remains with life savings taxed at a marginal tax rate but the tax arbitrage in favour of competing products such as MFs is gone now, which, at these valuations, is a small positive for life insurers, the institutional brokerage firm said.

Yet, shares of Life Insurance Corporation of India, SBI Life Insurance, and HDFC Life Insurance were all in the red.

For banks

Earlier, the interest on bank deposits was taxed at the individual’s tax rate and debt MFs enjoyed LTCG of 20 percent with indexation and life savings products enjoyed tax-free returns, CLSA said.

“At the margin, this is positive for banks but quantum cannot be very high as bank deposits’ market size is Rs 180 trillion vs total debt MF size of Rs 8 trillion,” it added.

Read here | Banking Turmoil Sparks Increased Risk Perception Among Fund Managers: BofA Survey

The Nifty Bank index was down 0.2 percent.

For NBFCs

According to CLSA, nonbanking finance companies and housing finance companies rely to some extent on funding from MFs. With potentially lower inflows in debt MFs, they may have to rely more on bank funding than on funding from MFs.