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New Finance Bill section to dampen equity investments

K Ram Kumar

Financial institutions and corporates will no longer be interested in making investments in equity, especially out of borrowed funds, thanks to the insertion of a new section-Section 14 A-in the Finance Bill, 2001.

The section does not allow deduction of expenditure relating to income which is not chargeable to tax.

For the same reason, banks and corporates have pulled out funds to the tune of Rs 1 billion from mutual funds.

So far FIs and corporates were allowed to offset the loss in their equity investments against the capital gains, making equity investment an attractive treasury operation. The new section has denied that benefit to the corporates and FIs.

Dividend income is normally not sufficient to cover the cost of funds invested in equity. Since this loss cannot be set off against capital gains on other instruments-a benefit hitherto enjoyed-there will be higher tax outgo.

"Corporate investors will have to bear the brunt of the adverse impact of the new section on investments by them in shares and mutual funds. They will be better off if they invest in debt as debt income is not taxable. Moreover, the issue of disallowance will then not arise," said Kanu H Doshi, chartered accountant.

The new section has already started hurting the income schemes of mutual funds in as much as they are facing redemption pressure from banks, which have substantial investments in the funds.

Doshi pointed out that the Association of Mutual Funds in India had made a plea to the finance ministry against the new section in view of the fact that corporates and mutual funds were already taxed under Section 115 (O) and Section 115 (R) respectively of the Income-Tax Act.

"No deduction on account of interest is allowable while computing capital gains after the date of acquisition of equity. Therefore, in the light of Section 14A, interest outgo relating to investments made in equity is not allowable as a deduction," said a tax consultant.

For example, if a corporate borrows Rs 1,000 from a bank at 12 per cent interest and invests in shares paying a 10 per cent dividend, the dividend income is totally exempt from tax.

However, the interest paid (12 per cent) will not be allowed to be set off against any other income. It will be adjusted against the dividend income only.

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