Tax tweaks send foreign mutual funds into a 5-month outflow eclipse

Following alterations in the tax structure, mutual fund (MF) schemes that invest in overseas securities have experienced a sharp decline in inflows.

In the first five months of 2023-24 (FY24), international MF schemes have received an average monthly gross inflow of only Rs 270 crore, compared to Rs 490 crore during the same period in the previous year.

This decline persists despite nearly all fund houses opening subscriptions for such schemes, with higher redemptions creating headroom for fresh investments.

At the end of January 2022, fund houses were compelled to limit inflows into their schemes as they neared the exhaustion of the $7 billion overseas investment limit.

Since then, they have been permitted to open their schemes for subscription only when redemptions create headroom for new investments.

In March, international MF schemes were hit with a tax blow when the government decided to revoke the tax benefits enjoyed by debt and international MF schemes.

Starting this financial year (FY24), any MF scheme that invests less than 35 per cent of its corpus in Indian equities is subject to investor-slab tax rates.

Previously, these schemes were eligible for long-term capital gains taxation — 20 per cent tax on gains, along with indexation benefits for investment periods exceeding three years.

Due to the decline in gross inflows and a surge in redemptions, net inflows into fund of funds (FoF) investing overseas have seen net outflows for five consecutive months.

In this period (April–August), investors have withdrawn a net total of Rs 1,670 crore from overseas FoFs.

Analysts assert that although taxation is a factor, flows into international schemes will continue to be driven by return expectations.

“Money will again start to flow in, especially in US funds, if there’s a good enough trigger for it — like valuation comfort after any sharp correction or allying of recessionary fear.

“The US market is an important geography from a diversification point of view, considering the quality of companies across sectors and possibilities of gains through rupee depreciation.

“However, we will now see more of an opportunistic money flowing in, given that there’s no added tax advantage to invest for longer duration as it was before the recent taxation change,” said Rahul Jain, senior vice-president research, International Money Matters.

From an asset allocation perspective, advisors are now exploring domestic schemes with substantial allocations in international equities.

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