Fund houses hit ELSS merger hurdle

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Despite repeated nudges by the capital market regulator, Securities and Exchange Board of India (Sebi), and some progress being made by the mutual fund (MF) industry, it seems that scheme mergers have hit a little snag. How should fund houses merge their multiple tax-saving or equity-linked savings schemes (ELSS)?

Although most fund houses have only one tax-saving scheme, some such as HDFC Asset Management Co. Ltd and Birla Sun Life Asset Management Co. Ltd, have more. This is because over the years they had acquired other fund houses, and such acquisitions brought with them other tax-saving schemes. Since these schemes offer tax deduction benefits under section 80C of the income tax Act, fund houses had, so far, chosen to let all schemes continue.

Typically, when a fund house has similar schemes it repositions one as, say, a mid-cap oriented scheme, and the other one continues as, say, a large-cap scheme. However, as ELSS have to be approved by the Central Board of Direct Taxes (CBDT) and Sebi before being launched, fund houses had chosen to let them continue, despite the apparent duplication that could happen post-merger.

However, Sebi is now nudging the industry to merge all identical schemes including ELSS. Also, Union Budget 2015 had clarified that merging two or more such schemes would not attract capital gains tax. Budget 2016 further clarified that even if two or more plans merge (say, a dividend plan gets merged with a growth plan in the same scheme), capital gains tax will not be charged.

What messing the merger

“Since the CBDT gives approvals to fund houses for every tax-saving scheme’s launch (after Sebi’s approval), we might have to go to the CBDT to ask for its approval again if we plan to merge ELSS,” said an equity fund manager of a mid-sized fund house. A senior CBDT official who spoke to Mint on condition of anonymity, however, said the department had not received any proposals yet from the MF industry about scheme mergers.

The chief executive officer of another fund house said that there was no need to go to CBDT for approval. “If an investor gets her tax deduction benefits at the time of making the investment— as per section 80C norms—then she will not get another tax benefit at the time of merger, even though the value may go up. It won’t be a fresh investment. Besides, the Finance Bill has clarified that ‘scheme’ and ‘plan’ mergers will not attract capital gains. So where is the question of going to the CBDT?”

A senior industry executive from a fund house, which has two tax-saving funds on account of an acquisition, said that there may be a way out. If it is decided that scheme A will be merged into scheme B, the fund house should stop accepting money in scheme A. As soon as investors in scheme A complete their 3-year lock-in (which all tax saving schemes have), they should be given an exit option; either exit the scheme or stay invested.

The latter option would mean investing in scheme B. This method, however, would entail that the two schemes have to be maintained till such time that all investors of scheme A complete 3 years. Whatever be the way out, scheme consolidation bodes well for investors, especially as the MF industry has over 2,000 schemes with several overlaps.