The Union Budget 2024-25 brought some changes in taxation with regards to certain categories of mutual funds. Here’s how your taxation will be affected after the change
Your allocation to various assets, including mutual funds, should be based on your investment objectives, risk appetite and investment horizon. However, certain developments have taken place recently, which to an extent could have an impact on your investing decision in certain categories of mutual funds. Let’s take a look at these mutual fund categories in detail.
Fund of Funds (FoFs)
Fund of Funds (FoFs) are mutual funds that invest in other funds. The purpose is to get the features of other funds in one wrapper fund.
The logic to invest in FoFs is that they manage the allocation to the underlying funds, usually equity and debt, in accordance with a certain risk profile and mandate. You can do this at your end, too, by investing in pure equity funds or debt funds, or by investing directly in equity stocks and bonds.
However, when you do a portfolio adjustment yourself, there is a tax implication that has to be taken into consideration. So, when you are moving from one fund to another, it will be considered as a sale and purchase, and there will be consequent tax impact on the transaction. When you sell and purchase equity stocks or bonds, there is a tax impact, too. A mutual fund, per se, is a tax-free entity; the tax you pay is on your gains and payouts. Hence, as long as your objectives and the mandate of the fund matches, there is good reason to invest in FoFs.
Now there is a favourable change in taxation of gains from FoFs. Till July 22, 2024, in the growth option of FoFs, the gains were taxable at the marginal slab rate (MSL), which for many investors in the highest tax bracket, was 30 per cent plus surcharge and cess. After July 23, 2024, provided you hold on to the fund for a minimum of two years, it will be taxed at 12.5 per cent plus surcharge and cess.
One counter-argument against FoFs is that there are two layers of expenses charged on FoFs: once in the underlying fund and once in the wrapper fund. This is something that the investor has to consider.
There is also a Securities and Exchange Board of India (Sebi) regulation on the expenses that may be charged to a FoF, including on both the layers.
In both index funds and exchange-traded funds (ETFs), total expenses, including on the underlying funds should be within 1 per cent. For FoFs investing in equity funds, it should be within 2.25 per cent, including the underlying funds, and in other FoFs, the ceiling is 2 per cent.
Gold And Silver ETFs
Given the geo-political uncertainties and the increased buying of gold by the central banks across the world, there is enhanced reason to have some gold in your portfolio.
In the latest Union Budget (Budget 2024-25), subsequent to the reduction in customs duty, there was a fall in domestic gold prices. However, this is a minor factor in the overall scenario, and gold prices have risen again. The big picture is that for diversification purposes, you should have an allocation of 10-15 per cent in gold. One fact that remains constant is that the aspects driving the global price of gold remains intact.
"The changes in the taxation of certain categories of mutual funds could impact your investing decision"
Domestically, the most recent development is that the government might stop the issuance of sovereign gold bonds (SGBs). The rationale behind introducing SGBs was to reduce the import of gold and ease the burden on the exchequer. But now, with the government reducing the customs duty on gold imports, it would be counter-intuitive to issue SGBs. So far, SGBs that have matured have been a cost on the exchequer as there was no hedge by the government on gold.
The implication for the investor is that SGBs, at least the existing series, offer a rate of interest of 2.5 per cent over and above the price appreciation of gold. There are multiple other avenues for taking exposure to gold, but those offer only the price appreciation of gold.
Two other gold investments are gold ETFs and FoFs investing in gold ETFs. You can purchase ETFs from the secondary market. If you do not have a demat account or one with a broker, you can purchase FoFs by investing in gold ETFs.
Here as well, there has been a change in taxation in the latest Union Budget. Till July 22, 2024, the gains from gold ETFs were taxable at the marginal slab rate. After July 23, 2024, provided you hold on to them for a minimum of two years, they would be taxable at 12.5 per cent, thus making them more tax efficient.
Hybrid Funds With Equity Exposure Of 35-65%
Hybrid mutual funds with equity exposure in the range of 35-65 per cent in their portfolio had a different tax treatment, subsequent to the Budget and Finance Act of the previous year.
In this category of funds, till July 22, 2024, provided you held on to these funds for three years, they were taxable at 20 per cent after the benefit of indexation. Now, this category of funds is taxable at 12.5 per cent, after a holding period of two years.
"Taxation of FoFs, silver and gold ETFs, and hybrid funds with equity exposure of 35-65% is better than earlier"
The categories discussed above—FoFs, gold ETFs and hybrid funds with domestic equity in the range of 35-65 per cent, would have the same rate of taxation as equity funds, which is 12.5 per cent, with only one difference. The holding period required is two years against one year required for equity funds in order to be eligible for long-term capital gains (LTCG) taxation.
International Funds
In international feeder funds and international ETFs, there are limits imposed by regulators on the amount of money that can be accepted by the mutual fund industry. The limits are $7 billion for international funds and $1 billion for international ETFs.
However, certain asset management companies (AMCs) are accepting fresh money, against redemptions. As and when there are redemptions in an international fund, it implicitly opens up fresh limits.
Even in these categories, the same taxation change has taken place. So, provided an investor has held on to these funds for two years, such investments would be taxed at 12.5 per cent.
Conclusion
The funds mentioned above should, typically, form the satellite component of your portfolio. Gold is a portfolio diversifier, international funds are handy if you have to remit money abroad, and FoFs and hybrid funds do the allocation into equity and debt at the fund level with non-taxable churning.
After the latest Union Budget, the taxation of these categories of funds is better than earlier. You only have to gauge if they are the right fit for your portfolio.