Open-ended mutual funds dividend policy: A discriminatory tax treatment

Many investors in Bangladesh turn to open-ended mutual funds to grow their assets and diversify their income.

However, as capital naturally flows toward avenues offering maximum returns, a tax code that discourages mutual fund investments can significantly impede their growth.

The current Income Tax Act 2023 presents two key discrepancies in the tax treatment of open-ended mutual funds compared to listed securities, particularly impacting small investors: tax rebate disparity and capital gains taxation.

Tax rebate disparity

Individual investors can claim a tax rebate on investments of up to Tk66.67 lakh in listed securities, including closed-end funds. The amount is only Tk5 lakh for open-end mutual funds as the investment above the limit does not help add to tax rebates.

This disparity reduces the appeal of professionally managed open-ended funds, which provide a safer and more diversified investment option compared to direct investments in high-risk listed securities.

Tax on capital gains

Individuals' capital gains of up to Tk50 lakh per year from direct investments in listed securities are exempt from capital gains tax.

However, due to mandatory dividend distribution provision of Mutual Fund Rules 2001 of Bangladesh Securities and Exchange Commission (BSEC), these gains are realised and distributed as cash dividends, subject to a 10% tax at source.

Subsequently, the open-ended mutual fund investor needs to pay more tax at their marginal tax rate if there were more taxable income.

Depending on an individual's circumstances, the tax burden may exceed 25%, effectively taxing capital gains, even for small investors who would otherwise be exempt.

This discrepancy can significantly erode small investors' returns, discouraging them from investing in mutual funds.

The need for a level playing field

The convenience offered to investors by open-ended mutual funds is great and that is why open-ended mutual funds are significantly outgrowing the closed-ended ones.

To encourage long-term investment and promote market stability, a more equitable tax treatment is essential.

By aligning the tax policies for open-ended mutual funds with those of listed securities, the government can stimulate the growth of the mutual fund industry and foster a more mature capital market.

A level playing field will not only attract more investors but also encourage institutional fund managers to adopt a long-term investment approach, reducing market volatility and deepening liquidity.

*The writer is the Managing Director and CEO of Ekush Wealth Management Limited