Mutual funds get a beating

Under Section 54EA, the entire proceeds from the sale of a capital asset are invested in a mutual fund for a period of three years to avoid tax outgo on the earned profits. In the case of Section 54EB, the profits arising from the sale of a capital asset are parked in a mutual fund for a period of seven years to avoid any tax payment.

Mutual fund officials blame the banking industry for the 100 per cent increase in dividend tax from 10 per cent to 20 per cent. “With an astronomical growth in collections of mutual funds, especially the debt funds, banks and FIs were beginning to feel the heat,” says an analyst. “The government plans to earn higher revenue since corporates were paying only 10 per cent dividend tax in mutual funds compared to 38.5 per cent in other instruments,” he adds.

However, industry sources do not see any panic redemption from debt funds. “Corporates will now be paying a 20 per cent dividend tax which is still lower than the normal tax charge of 38.5 per cent,” says the marketing head of a mutual fund.

Some investors are now expected to shift their investments from dividend option to growth option under a debt fund. “If an investor exits from a debt fund after one year, he will have to pay a 20 per cent tax on the realised capital gains but with indexation benefit. This will work out to around 15 per cent, based on current inflation levels. This is lower than the 20 per cent dividend tax,” says an analyst.

The increase in dividend tax to 20 per cent could spell trouble for monthly income plans, which has been the top grosser for the Unit Trust of India. MIPs are also finding favour with private mutual funds, since the 15-20 per cent equity exposure helps generate higher returns than a normal debt fund. “With a 20 per cent tax rate and falling interest rates, coupons on UTI’s MIP are now expected to fall further. On an average coupon of 13 per cent, UTI is likely to offer not more than 9.5 per cent in its MIP,” says an analyst.

The higher dividend tax is expected to see increased inflows in balanced funds, which have more than 50 per cent equity exposure. “For the retail investor at least, a balanced will now have the added advantage of a zero dividend tax, besides an ideal mix of debt and equity,” says an industry observer.

Bankers happy with budget

MUMBAI:Government-owned banks and financial institutions hailed their political master, Yashvant Sinha’s budget saying that overall interest rates would come down due to cut in providend fund rates.

Says S Rajagopal, CMD of BoI: "The removal of the two per cent interest tax on banks’advances should benefit the industrial sector by about Rs 100 crore. To that extent, it lowers the cost of borrowing for industry." "The cut in the general provident fund rate by one per cent only reinforces the trend towards lower interest rates. When they will fall further, will have to be seen from the actions of authorities," he said

"The government decision to lower its stake in nationalised banks to 33 per cent means we will have to look at the market for our funding needs in the future. We cannot expect capital from the government. This will force banks to improve performance, improve corporate governance," he said.

Chairman State Bank of India, however, said he did not think the budget signalled an imminent cut in interest rates. "The budget as such does not directly signal an imminent cut in rates," SBI Chairman G G Vaidya said.

The Reserve Bank of India Deputy Governor Venugopal Reddy said the 2000-01 budget has taken solid initiatives and given a very good package for the financial sector as a whole. He cited setting up the credit information bureau and a slightly modified strategy towards recapitalisation of weak banks. The government has “a very good chance” in controlling the increasing market borrowings as the economy is recovering, Reddy said.

On the fiscal deficit, Reddy said it is “somewhat higher than expected” and added that the RBI is “not worried but naturally concerned” over the burgeoning fiscal deficit target of 5.6 per cent of GDP. Since the economy is improving and sanctions have been eased, fiscal deficit management would be easier now, he added.