AMFI Seeks Clarity on Taxability of Side-Pocketed Funds

The Association of Mutual Funds of India (AMFI) released their list of expectations and recommendations for the upcoming full Union Budget, which is set to be presented on 5 July 2019. The most prominent expectation is to have clarity on the taxability of side-pocketed funds.

Side-pocketing is a procedure encouraged by the market regulator Securities and Exchange Board of India (SEBI). It enables mutual funds to allocate a definite number of fund units against lousy debt held by them in times of financial distress. It was implemented in December 2018.

The debt mutual funds have slumped of late, and lack of clarity on the taxability of side-pocketed fund units have added to the worries of debt investors. The side-pocketing procedure was implemented to let the investors exit the fund in case of financial distress. 

The debt mutual funds can implement side-pocketing if the holdings are depreciated to an extent below the grade of investment or are affected due to a default. Side-pocketing enables separation of units and forms a new portfolio which requires no fresh inflow of cash.

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The new portfolio will have its own net asset value (NAV). The investors are allowed to redeem units when they recover money. Taxing these fund units will only add to the burden of debt investors who have already suffered losses due to a recent downgrade in the debt funds. 

The market watchdog believes that the Income Tax Act, 1961 does not clearly define the taxation of side-pocketed funds. The current tax provisions do not consider the date of acquisition of side-pocketed funds as the date on which the actual investment was made. It considers the date on which the side-pocketing was done as the date of investment. 

The existing tax rules account the acquisition cost as the original acquisition cost and not the proportionate cost on the side-pocketing date. This hampers investors in terms of capital gains when they sell their mutual fund units. AMFI has urged the Finance Ministry to look into this issue and address it in the upcoming budget.

Apart from the clarity on the taxability of side-pocketing funds, the AMFI is expecting the following from the 2019-20 full Union Budget:

• Tax relief for investors invested in infra sub-sectors.
• Removal of dividend distribution tax on equity-oriented mutual funds.
• Withdrawing LTCG tax levied on the equity-linked mutual funds.
• Exemption of Securities Transaction Tax (STT) on the redemption of fund units.