Ensuring level-playing field for growth of mutual funds

The unequal taxation policy surrounding mutual funds in the capital market of Bangladesh raises concerns regarding the fairness for mutual fund investors. Specifically, the issue lies in the taxation of cash dividends from open-end funds, creating an imbalance between individual's listed securities investments and mutual fund investments.

When an investor engages in direct listed securities investment and realises a capital gain after holding for a period of time, the gain remains untaxed. However, if the same investor opts for an open-end fund, the capital gain generated by the fund when distributed as cash dividends becomes subject to taxation. This incongruity arises due to the mandatory provision which is compelling open-end funds to distribute realised gains as cash dividends.

We have analyzed the financial statements of all 91 funds of the mutual fund industry in 2021 and found that 62 percent of the total income of all mutual funds comes from capital gain, 26 percent from dividend income, and the rest from interest income. This means most of the portion of dividends distributed to investors comes from capital gain.

Consider an open-end fund that purchases the shares of Square Pharma Ltd at Tk 200 each and sells it at Tk 300, resulting in a capital gain for the fund. While the fund itself incurs no tax, a subsequent Tk 100 dividend declaration triggers a tax on dividends at source.

Further, investors, who face additional taxes based on their marginal tax rates, experience an overall tax burden on their investment. This disparity discourages mutual fund growth compared to direct securities investments in the exchanges.

Investors often choose mutual funds for professional management as they lack the time or expertise for securities analysis. However, current tax structures favour direct investments, contributing to a retail-driven market where brokers function as de facto fund managers. This retail-driven dynamic leads to herd behaviour and increased market volatility during bearish movements.

The Income Tax Act of 2023 further exacerbates the issue by offering higher tax rebates for direct market investments compared to mutual funds. If a person invests in mutual funds, she will get a tax rebate on a maximum of Tk 5 lakh.

If she invests directly in the market, she will get a tax rebate on Tk 67 lakh. This discrepancy acts as a deterrent for potential mutual fund investors, hampering the sector's growth.

Globally, mutual funds get preferential treatment so general investors are encouraged to invest through professional fund managers. Comparisons with other markets reveal that India maintains an equitable tax treatment for equity and mutual fund investments, promoting a balanced investment landscape.

An Indian invests 40 times more than what we Bangladeshi do in mutual funds. Even Pakistan, despite its lower GDP than Bangladesh, witnesses three times more investment per citizen.

Addressing discriminatory taxation policies is crucial for the sustained growth of mutual funds in Bangladesh. Without a level-playing field, inefficiencies in financial intermediation, a lack of depth in the capital market, and increased volatility may persist. It is imperative for stakeholders to acknowledge and rectify this issue to ensure a robust and equitable financial ecosystem.

The author is managing director of Ekush Wealth Management Limited