Budget 2019 India: The Fund of Funds is a mutual fund scheme which invests in other mutual fund schemes but does not directly invest the investor's money into the assets such as debt securities or equity shares.
Union Budget 2019 India: The Budget 2019 has proposed a change in the taxation rules for the fund of funds (FoF). The proposal is to allow the concessional rate of tax for short-term capital gains on the transfer of units of FoF. The Fund of Funds is a mutual fund scheme which invests in other mutual fund schemes but does not directly invest the investor’s money into the assets such as debt securities or equity shares. There are debt FoF as well as equity FoFs and their taxation differs. “Currently all FOFs irrespective of the underlying asset class gets taxed as per debt fund taxation. The concessional short term cap gains is being proposed for certain type of FoF only and not all of them,” says Lakshmi Iyer, Chief Investment Officer (Debt) & Head Products, Kotak Mahindra Asset Management Company.
Budget 2019 has proposed to tax equity-oriented FoF as that of equity fund’s STCG rate i.e. at a concessional rate of 15 per cent. The Budget document states, “It proposed to amend section 111A so as to extend the concessional rate of tax for short-term capital gains in respect of the transfer of units of such (equity-oriented) fund of funds.”.
As per current income tax rules, an equity oriented fund would be the one in which more than 65 per cent of the corpus is invested in equity shares. While the long term capital gains (LTCG) in equity funds ( including equity shares) is at the rate of 10 per cent (without indexation benefit) on gains exceeding Rs. 1 lakh provided transfer ( after 12 months) of such units is subject to STT, the short-term capital gains is at a concessional rate of 15 per cent. For mutual funds other than equity schemes such as debt funds, the LTCG tax is 20 per cent with indexation, while STCG is as per one’s income tax rate.
FoF is generally taxed as per the taxation structure of debt funds. However, Budget 2018 had provided a concessional rate of long-term capital gains tax under section 112A of the Act for the transfer of units of such fund of funds (equity-oriented) i.e. similar to equity LTCG taxation.
“As of date, there are no FOFs that invests in a CPSE fund or CPSE ETFs. Such structures could work well in a country like India where demat penetration is low as FOF is like another other MF scheme unlike ETF where demat account is mandatory,” says Iyer.
To invest in ETF such as CPSE ETF, one needs to have a demat account. However, for FoF, there is no such need and one may invest directly with the fund house or through a mutual fund distributor. While the new proposal may help investors to look at equity-oriented FoF because of its tax-friendly structure, it remains to be seen if FoF to invest in CPSE ETF’s gets launched and whether they too will get the tax advantage of income tax deduction.