Urge Nirmala Sitharman to treat ETFs on equal footing with ELSS for taxation

During the pandemic, people experienced firsthand the importance of liquidity. According to RBI’s 2017 household finance survey, Indians invest 84% of household wealth in real estate and other physical assets, with 11% in gold and just 5% in financial assets.

The pandemic has shown us that a liquid emergency fund is essential in times of uncertainty. Thus, the rapid increase in the number of new DEMAT accounts in FY21 – three times the number of the previous year – is a clear indication of increased interest in the stock markets. Additionally, the rise of new age discount brokerage firms that offer seamless digital and onboarding experiences, and a host of actions taken by SEBI have played a crucial role in this regard.

Despite this massive increase, there is still a long way to go to ensure active participation in equity markets by retail investors who are otherwise comfortable with low-yielding products such as fixed deposits/pension plans or illiquid assets such as land or real estate.

How can the regulator/government encourage capital deployment, support interest and help educate retail investors?

Here is our suggestion to the Ministry of Finance to consider in the FY22-23 budget

Treat equity-based exchange-traded funds (ETFs) on an equal footing with equity-linked savings schemes (ELSS) for tax purposes

We recommend the following:

• This will provide a significant boost to small retail investors seeking alternative instruments of tax benefits under provision 80C of the Income Tax Act.

• ETFs are a great financial product for new retail investors and offer similar benefits to mutual funds, but only at a fraction of the cost. Because they are passively managed, ETF expense ratios, in some cases, are 10 times lower than the average mutual fund.

• The provisions of the ELSS scheme, 2005 (IT) should be made applicable to ETFs based on shares, as mentioned in rule 3 of the same law. For example, investments in ETFs must be held for a minimum period of 3 years to benefit from the tax advantage. This may be limited to ETFs whose underlying assets are equity instruments.

• The direct benefit would be an increase in capital inflows into ETFs and, therefore, an improvement in market capitalization. We expect at least a 3x increase in ETFs whose total size of assets under management was around Lakh 2.9 crore at the end of FY21 (SEBI data) – 1/10th the size of the mutual fund industry. The more liquidity (higher AUM), the more effective ETFs are as an instrument.

• The indirect benefit of this would be an active use of DEMAT accounts by retail investors to explore other stock products as well. ETFs will break the entry barrier for household investors to start investing in the markets. This will lead to higher market capitalization of Indian markets and more liquidity.

• This will provide equity markets with a boost that the mutual fund industry received a decade ago.

Fiscal Outlook for Fintechs

Considering the Omicron wildfire and the government’s ongoing digitization initiatives, Fintechs will also continue to benefit in the coming seasons. While the budget is expected to be expansionary, with a focus on health care, infrastructure and even green investments (read: the electric vehicle industry), there is also a need to help small businesses through various programs and tax benefits.

For the Fintech space, here’s our outlook for the budget

• As SMEs are adopting new era fintech/neo-banking companies such as Open, Razorpay, BharatPe, etc., the government should consider these companies as an effective channel to communicate with SMEs. The government should consider using these companies to pass on the direct benefits of taxation, GST or any other regime to MSMEs. This will position the fintech industry as trustworthy, while providing a clear view to government on capital deployment and program success. This mention will also increase the awareness of these platforms in the whole MSME sector.

• The government must continue to support the emergence of new era banking. A parliamentary working committee is to be set up to work on a framework for a fully digital bank based on the recent white paper published by NITI Aayog. While the framing will certainly take time, a mention in the budget will give a big boost to the nascent neo-banking sector.

(Kashyap Mahavadi is the managing director of Dinero – neobank)

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Posted: Saturday, January 22, 2022, 3:41 PM IST

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