Stamp duty on MFs to reduce portfolio churn by investors

The imposition of stamp duty on mutual funds will impact in case of churning the portfolio and will encourage the investors to stay invested for a longer duration.

Any transaction that results in issuance or transfer of units to the investor will be subject to stamp duty. Effectively, it will act as an entry load as allocation of units will be at net amount post deduction of stamp duty.

According to a report by JM Financial, investors in overnight/liquid fund category with investment horizon of seven days and below will have negative impact due to stamp duty levied.

"Imposition of stamp duty will impact in case of churning the portfolio. It will encourage the investors to stay invested for a longer duration and not churn portfolio for higher yields," the report said.

In case of early exit from a fund, the impact of the stamp duty is higher and it reduces with the increase in investment horizon which essentially will reduce the churning. It will have negative impact on the institutional clients who park their short-term money in liquid or overnight funds.

Decreasing yields and additional expense of stamp duty will have negative impact on the overnight/liquid category, the report said.

In comparison with FD returns, the impact of stamp duty is high in case of short holding period of less than seven days. Generally, fixed deposits are for duration of more than seven days. The comparison between the bank FD returns and liquid/overnight returns shows that overnight and liquid funds are still better placed as compared to FD returns.

The Finance Act, 2019, amended the Indian Stamp Act, 1899, to create a mechanism to enable states to collect stamp duty on all securities market instruments, including mutual fund units.

The Government of India in December 2019 had amended the stamp duty regime on issuance and transfer of shares, debentures, futures, options, currency and other capital market instruments. This was to be originally effective from January 9, 2020 but was later postponed to be effective from July 1, 2020.

A stamp duty of 0.005 per cent will be levied on issuance of units and 0.015 per cent on transfer of mutual fund units.

Stamp duty is applicable in the instance of investment, i.e., buying of units. Hence, any transaction that results in issuance or transfer of units to the investor will be subject to stamp duty. Effectively, it will act as an entry load as allocation of units will be at net amount post deduction of stamp duty.

The transactions which attract 0.005 per cent duty are purchase of units, switch-in of units, systematic investment or transfer installments (SIP/STP) and dividend reinvestment of units.

The transactions which attract 0.015 per cent duty are buying units on stock exchange through a stock-broker, for e.g. ETF, closed ended schemes, off-market transfer of units, i.e., transfer of units from one demat account to another demat account.

According to a report by B&K Securities, the stamp duty will be like an entry load, hence the allocation will be for net amount after deduction of stamp duty.

The impact of stamp duty on overall returns reduces as the investment horizon increases. The report said that selection of right investment category according to the investment horizon will be of benefit to the investor, as it will ensure that stamp duty is not paid repeatedly on same investment.