Sucheta Dalal :Mutual Funds dunked in the turnover soup
Sucheta Dalal

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Mutual Funds dunked in the turnover soup  

Jul 12, 2004


Isn’t it a pity that all that is good in Chidambaram’s Budget has been overshadowed by the thoughtless provisions on transaction tax for capital market trades? For instance, the Finance Minister has blessed the creation of a separate trading platform for Small and Medium Enterprises, which is a big and much needed move that could breathe some life into a couple of smaller stock exchanges.

Similarly, the acknowledgement of the long pending demand for better coordination between commodities and capital markets is a significant move. This is expected to lead to the Forward Markets Commission (FMC) being taken over by the Securities and Exchange Board of India (Sebi). Commodities dealers say this move is urgently required since most FMC staff is clueless about the rudimentary details of automated trading, let alone regulate sophisticated electronic markets and derivatives trading.

On the other hand, the Budget blunders far outstrip its positive measures. The finance ministry has blundered badly on transaction tax for the debt market and equity-based mutual funds. The post-Budget debate threw up a number of opinions with many saying that the 0.15 per cent tax is peanuts compared with the 1 per cent brokerage that investors used to pay once upon a time. The height of absurdity was when a Communist leader, who probably doesn’t even have a nodding acquaintance with the capital market, sneered about the brokers’ protests against transaction tax. We have had other pearls from bureaucrats who have questioned why brokers are protesting a tax that will have to be paid by their clients. The simple answer is that when clients disappear, the brokers’ business will vanish too. Also, when investors paid a 1 per cent brokerage, the daily market turnover was barely Rs 200 crore (compared with Rs 10,000 crore today), so a turnover tax would have earned precious little for the government then.

Clearly, many of these anti-market attitudes stem from the belief, even among policy-makers, that the capital market is a gambling den (in may ways day-trading and scalping is gambling, but the answer is to legitimise casinos and tax those heavily) where all investors make large chunks of money and pay no taxes.

Let’s start by detailing the taxes and charges actually paid by investors today without even earning a rupee in profits. Every transaction attracts brokerage, the quantum of which depends on whether the trade is for delivery, will be squared off the same day, or is carried forward (as a futures position). It then attracts stamp duty (again depending on the kind of transactions), service tax and a variety of charges related to dematerialisation, custody and maintenance of a Depository Account. Some of these accounts have mandatory bank deposit requirements that block up funds. In addition, the investor pays income tax at the rate of 33.6 per cent for normal speculative transactions, and either short-term or long-term capital gains tax, depending on when shares are sold.

Clearly, investors’ activity sustains capital market infrastructure, several institutions and generates a lot of employment. Many investors, especially retail ones, have complained bitterly about high demat and custody charges, but the Sebi has yet to stir itself enough to reduce the charges. Now the Finance Minister wants them to pay transaction tax, and a lower short-term capital gains tax. Even that may not have been an issue, (doesn’t matter that the tax will be paid whether or not they earn any profit) if it weren’t so high.

Can those investors, who find direct trading much too expensive and complicated, turn to equity mutual funds? After all, hasn’t the government itself been encouraging investors to turn to expert fund managers? Well, not anymore. At least not unless the finance ministry rectifies another major Budget bungle.

After Chidambaram’s not-so-dreamlike Budget, it is suddenly very foolish for investors to put their money in equity mutual funds. That is because, while the government scrapped long-term capital gains tax and pruned short-term capital gains to 10 per cent for investors, it forgot to extend the benefit to equity mutual funds. This means that an individual trading directly will pay only 10 per cent tax, but if the investment is routed through a mutual fund, the old taxes apply.

Clearly, there would have been a rush to exit equity mutual funds, weren’t it for the fact that most people believe that the finance ministry has to correct its mistake. But isn’t it time that someone was held accountable for this needless trauma even as a senior ministry official claimed that detailed studies were made before the Budget proposals were formalised?

At the moment, the Association of Mutual Funds of India (AMFI) has completed a brainstorming session on Friday and will soon queue up before the finance ministry, along with debt market intermediaries, brokers and investors for some relief. But the longer the government delays corrective action, the more it hurts investor interest — especially of those who want to get out.

Meanwhile, since the debt market has shut down after Budget day, mutual funds have stopped giving out fresh Net Asset Values (NAVs) on all funds. Instead, they are using old valuations of gilt-edged securities.

This has created another set of problems. Exiting investors can redeem their units at a historical NAV (according to mutual fund rules), but what about those who stay on? If equity values erode over the next few days, then exiting investors stand to benefit, while those who stay on, reassured by Friday’s artificial rally, could end up as losers.

Considering the volatility in the debt market on expectations of interest rate hikes, this situation endangers investor interest and has to be rectified speedily.

After all, why should retail investors who have put their money into equity funds have to suffer because the finance ministry mandarins miserably failed to do their homework? The biggest irony is that securities transaction tax has ended transactions at all in mutual funds and debt securities.

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-- Sucheta Dalal