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Absence of sops reduce mutual fund inflows

Aabhas Pandya

The withdrawal of sections 54EA and EB in the last Union Budget, which came into effect from September 30, 2000, is beginning to pinch the fund industry. Marketing heads at asset management companies and distributors concede in unison that the absence of this vital tax-break has had an impact on fresh collections, especially when mergers and acquisitions are again beginning to hot up in the Indian corporate sector.

Last year mutual funds garnered a substantial booty from cash-rich promoters under these sections, who were exiting their businesses with large capital gains. According to back-of-the envelope calculations, the fund industry had mobilised around Rs 40-45 billion from investors in these sections last year.

It may be recalled that the government had abolished tax benefit under section 54EA and EB for mutual funds and instead, introduced tax breaks under section 54EC on five-year bonds from NHAI and NABARD.

"Since investments under section 54EA were locked for three years as opposed to seven years under section 54EB, the former was very popular among investors. We will always feel the impact since the industry was getting strong inflows under this section. Now, most investors will not be interested in putting money under bonds for five years and on the other hand, mutual funds will be deprived of long-term investments, especially for equity markets,'' says a source at Birla Sun Life Mutual Fund.

"We are not exactly feeling the pinch now since stock markets are not doing well and hence, there are not much capital gains. In the property market, it is more of lease deals rather than sale deals and hence, it is not immediately impacting mutual funds,'' says Prakash Dalal, marketing head, Kotak Mahindra Mutual Fund.

On the other hand, investors hardly have an option now since they either have to invest in infrastructure bonds or pay tax. "While some are ploughing back the money to main business after paying tax, others are investing in these infrastructure bonds to prevent tax liability though the returns work out to only around 10.5 per cent for a five-year period,'' says the head of a Delhi-based mutual fund distribution company. However, the alternative just doesn't seem to be working smoothly. "Apart from poor servicing, NABARD and NHAI bonds are not being distributed properly and thus, some investors are actually ending up paying tax,'' he adds.

Under section 54EA, the entire proceeds from the sale of an asset (including capital gains) were to be invested within six months of the sale in a designated security to avoid capital gains tax. This investment carried a lock-in of three years. Thus, investors who booked profits till March 31, 2000 could invest till September 30 in mutual funds to escape tax liability.

While there are no exact numbers to quantify inflows under section 54EA, industry managers say this money roughly accounted for 10 per cent of the total inflows in 1999-2000. "While it is very difficult to put a precise number, it was anywhere between 7-10 per cent, which is a huge amount. While collections have been hit, the government needs to review this since it is preventing the inflow of long-term money to equity markets," says Sandeep Mahajan, zonal head, Sun F&C Mutual Fund.

Capital gains apart, mergers and acquisitions are again beginning to hot up but unlike last year, the fund industry is nowhere in the picture. "We gained the most from M&As last year, with industrialists selling out their stakes and parking money with mutual funds to prevent tax liability. The M&A activity has picked up now but we no longer stand to benefit,'' points out Dalal.

Source: Value Research

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