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Business Commentary/A N Shanbhag

'Precious little was done to prop up the market until Sinha was forced to take concrete steps'

All schemes of the Unit Trust of India other than US-64 as well as those of mutual funds are based on net asset value. The concept of NAV did not exist in 1964 when UTI was born. UTI justifiably decided not to change the structure of US-64 when the awareness of NAV came into existence. The only mistake UTI made was to submit to unreasonable pressure from the authorities to bring the NAV of US-64 in line with its price.

Towards this end, it dished out preferential, rights and bonuses. But for this it would have faced absolutely no problem even when the equity market was languishing for over four years.

While the market was sliding down into what appeared to be a bottomless pit, the NAVs of equity-based MFs were tumbling too. Many of those who had gone to the market directly lost their shirts but had no one to blame but themselves.

However, those who had used the UTI and MFs found a peg to hang their accusation for their losses. The common man lost faith in MFs.

The authorities should have realised that the core of the problem was listlessness of the market and have taken steps to prop it up. Instead, the Securities and Exchanges Board of India forced parent organisations of MFs to rescue their children, but only in those cases where express promises were given of assured minimum returns.

Precious little was done to prop up the market until Sinha was forced by circumstances to take concrete steps in the right direction. UTI's promise is only an implied one, built over the last 35 years through its consistent and praiseworthy performance. In its effort to protect the investors, UTI took advantage of US-64 not being an NAV-based scheme, and maintained the dividend. Instead of appreciating UTI for this dynamic stance, UTI was accused for having eaten into its reserves and, thereafter, into the capital. Everyone expected the government, the parent of UTI, to come to its rescue.

Let us quickly browse through Mr Sinha's bail-out package has based on the Deepak Parekh Committee report. The package consists of three separate and strong actions:

• Rationalisation of indirect taxes to boost the market.
• Support from bottom to all MFs and UTI by making their dividends tax-free in the hands of investors.
• Implementation of US-64 specific action based on the Deepak Parekh Committee report. Accordingly, UTI will launch a brand new scheme, 'Special Unit Scheme 99' (SUS-99) with a corpus of Rs. 48.10 billion.

The government will buy the units and pay through the issue of government securities on a five-year term. SUS-99 will in turn buy PSU holdings of US-64 at their book value. In turn, US-64 will get securities bearing interest at terms and interest identical to its government securities.

Very complicated indeed. I have not understood the nitty-gritty. It is comforting to know that the government is taking a US-64-specific action. The dividend from UTI/MFs has become tax-free. Does this give any cause for celebrations? Let us see.

• If any debt based scheme, that is, scheme having over 50 per cent of the portfolio in debt instruments, desires to pay Rs 10 as dividend the exchequer will take away Re 1, leaving only Rs 9 as tax-free dividend for the investor. This is non-refundable tax at source applicable to retired persons, widows and all such typical small investors who depend upon the dividend from their investments for their daily bread and butter.

  Earlier, such persons could file Form 15-H to stop this tax deduction at source or could employ legal tax-saving devices to claim refund of TDS or adjust it against the tax payable on other incomes.

  Now the government will be collecting much more in its coffers through its tax-free mechanism than the taxable era.

• FA97 made dividend on shares tax-free but not on equity-based UTI/MFs. This was blatantly unfair. In spite of paying dividend tax on dividends paid by companies, the MF investor will be required to pay tax on distributed dividend paid by MFs. This was an apparent anomaly.

  It's completely unjustifiable and downright inequitable. Well, water finds its own level, and this has happened. UTI and MFs are after all a conduit between the companies and investors.

  It is my contention that the investors had earned this right when the dividend on shares had become tax-free. The question of dividend tax does not arise in the case of equity-based schemes since the dividend tax is collected by the exchequer before the company paid dividend to UTI/MFs.

  Unfortunately, the dividend tax exemption is slated to exist only for 3 years. Why is Mr. Sinha treating this as if it is a charity?

• Tax-tree dividend has had a strange and detrimental fallout. Deduction u/s 80L is available up to a ceiling of Rs 12,000 under the main provisions. Additional deduction of Rs. 3,000 was available for interest on government securities and income from UTI as well as MFs. Now what remains under this special category is the interest from government securities. I do not think that any retail investor would be interested in buying government securities. Consequently, ipso facto, the ceiling on Sec. 80L has been reduced from Rs. 15,000 to Rs. 12,000. I wish Mr Sinha had raised the general ceiling of Sec. 80L from Rs 12,000 to Rs. 15,000.

• The budget clearly states that the 'income' from UTI and MFs will be tax-free. I claim that the capital gains is part and parcel of 'income'. Does this mean capital gains of UTI/MFs escape the tax altogether. I do not think it is the intention of the Act. Yet, the question remains unresolved.

Investment strategy

The word, 'tax-free', is music to so many ears that people may impulsively go in for the dividend option and not the pure growth option of debt-based schemes. These investors miss out on the fact that the pure growth schemes were always far superior to the dividend schemes. These availed of the concessional flat rate of 20 per cent of capital gains tax, attracted the benefit of indexation. Moreover, even the resultant small tax can be saved by investing capital gains in schemes covered by Section 54 EB.

Debt-based schemes are liable to dividend tax for the dividend option but not for the pure growth option. Therefore, their propensity to earn higher returns than the dividend option has to be recognised by anyone interested in obtaining more mileage from his investible funds.

There is a widespread belief that this budget has brought the rate of capital gains tax down to 10 per cent. This is not strictly true. The rate of 10 per cent is only applicable in the case of shares and securities. UTI/MFs units do not appear to fall under the definition of 'securities'. Moreover, the 10 per cent rate is applicable without indexation. In other words, in the case of shares and securities, capital gains would be charged at a rate of 20 per cent with cost indexation or 10 per cent without indexation, whichever is lower.

Last but not the least, UTI Chairman P S Subramanyam was unfazed by the storm raised even though he was in the eye of it. He maintained that UTI was not, is not and will not be an NAV-based scheme. It is a different animal, not even a distant cousin of all the NAV-based schemes.

Immediately after the budget he said, "UTI would maintain its current dividend policy for US-64 scheme for the year ended 30.6.1999." Though he did not categorically quantify the dividend, I strongly feel the writing is on the wall.

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