Budget 2023: Taxation on mutual fund investments vs other asset classes

By Abhinay Sharma and Sakshi Jain
NEW DELHI: The Pre-Budget consultation for Budget 2023-24 concluded on November 28, 2022. Finance Minister Nirmal Sitharaman chaired the consultations, wherein representations from seven stakeholder groups were heard and effectively addressed. One such stakeholder in the consultation was Association of Mutual Funds in India (AMFI), which sought parity in taxation on sale of mutual fund units, as compared to the other assets, for the reasons mentioned underneath.
In this article, we would see, firstly, tax treatment on sale of mutual fund units versus other similarly placed assets; secondly, how different asset classes are taxed in India, and finally, what can be done to ensure tax parity among similarly placed asset classes so as to maximum tax revenue, while also ensuring convenience for the tax payers in the payment of taxes.
I. Taxation on Mutual Fund Investments vis-à-vis Other Asset Classes
The AMFI sought uniform taxation for capital gains from investment in Mutual Funds vis-a-vis Unit Linked Insurance Plans (ULIPS) because the existing taxation structure is skewed in favour of the latter even when both the products serve a similar purpose. Some of the concerns of the AMFI in this regard are as follows:
1. In case of Mutual Fund Units, Long Term Capital Gains Tax (LTCG) is exempted up to the gains of Rs 1 lakh and after that, LTCG is levied at the rate of 10 %, on the other hand, investments under ULIPs are tax free, provided that the sum assured is at least 10 times the premium paid and the money is withdrawn after a lock-in period of 5 years.
2. In case of Mutual Fund Schemes, the shift from Dividend to Growth Plan (and vice versa) / Regular to Direct Plan, requires simultaneous selling and buying of the mutual fund units, and thus, is subjected to Short/Long Term Capital Gains Tax, however, in case of ULIPs, a switch from one option to another is not considered as capital gain and thus, is not taxed.
Additionally, AMFI also pointed out the disparity in tax treatment of the sale of debt mutual funds units vis-à-vis listed debentures, which the AMFI wants the government to look in to. For example, while LTCG is levied on listed debentures at the rate of 10%, when it is held for more than 12 months, however, in the case of sale of Debt Mutual Funds Units, LTCG is levied at 20%, when the units are sold after more than 36 months.
II. Tax Treatment of the Other Asset Classes
The Income Tax Act of 1961 provides that any profit earned from capital assets, such as stocks, gold, mutual funds, real estate etc., is termed as capital gain, which in turn, is subjected to taxation, depending upon the type of investment and the period of holding of the underlying security. Additionally, while some of the investments, for example, debt funds and real estate, are entitled to indexation benefits, on the other hand, investments in other asset classes do not qualify for the same benefit.
III. Suggestions for the rationalisation of tax structure
The Government should rationalise the taxation of different assets, while ensuring parity in taxation of similarly placed assets. Some of the suggestions in this regard include:
1. Rationalisation of the holding periods For example, LTCG for sale of debt mutual funds units is levied, when they are held for more than 36 months, on the other hand, LTCG for immovable property is levied, when it is held for more than 24 months, despite latter being highly illiquid and prone to arm twisting mechanisms.
Thus, it is suggested, that the holding period for application of LTCG be reduced to 24 moths (from 36 months currently) for debt mutual funds, Gold ETF etc, while the same should be increased to 48 months or even more (from 24 months currently) for the real estate.
2. Rationalization of the Rate of LTCG. For example, investment in mutual funds and ULIPs are taxed differently, despite both of them being similar products. Thus, it is suggested, that both the instruments should be taxed in a similar fashion, so as to mobilise more investment for the Indian industry, while ensuring parity in taxation of similar assets.
3. Mobilisation of more investment into bonds and Government Security.
In this regard, it is suggested that in light of bond market being currently underdeveloped, the government can tax the sale of bonds in parity with equity instruments (at least temporarily), thereby, attracting household savings, which in turn, will fuel capital expenditure and job creation.
With all these steps combined, parity in taxation could be achieved. This will not only help taxpayers better understand, as to how, their assets are taxed, thereby, translating into better tax compliance, but also, it will lead to tax buoyancy, the proceeds of which can then be used for social and capital expenditure by the government.
Abhinay Sharma is Managing Partner and Sakshi Jain is an Associate at ASL Partners