Now that final withdrawals from savings schemes like NPS will become completely tax-free, they could potentially compete with the mutual fund industry

With the government proposing a long-awaited move to free long-term savings products from tax liability, schemes like the government's own baby the New Pension Scheme will potentially make life even harder for equity-linked mutual funds, which are likely to come under long-term capital gains tax.

The NPS currently comes in two flavours, a Tier-I account where savings for retirement are contributed into a non-withdrawable account, and a Tier-II account-a voluntary savings account from which you are free to withdraw your savings whenever you wish. If the proposals in the revised Direct Tax Code (DTC) are implemented, withdrawals from a Tier-II NPS account would effectively be free from the burden of tax. This would allow investors to withdraw amounts from their NPS account to meet contingencies without worrying about the tax implications.

This is where the equity schemes of mutual funds will perhaps take a hit. The government has proposed to introduce capital gains tax on sale of shares held for more than a year. This would dampen the return expectations of mutual fund investors to that extent. In doing so, the move could also make investors find more favour with products like the NPS. If the proposals in the reworked consultative paper of the DTC are implemented, will the wheels come off the struggling mutual fund industry?

A certified financial planner made his worries about the possible fallout on the mutual fund industry quite clear. "If constant withdrawals from Tier-II accounts are permitted and allowed to be exempted from tax, it would have a negative impact on the mutual fund industry. The NPS will essentially come in direct competition with mutual funds. It will be a final nail in the coffin for this ailing industry."

The pension regulator, Pension Fund Regulatory and Development Authority (PFRDA), had been calling for this tax exemption for a long time. The NPS has been slow to take off. Now that the boost has finally come, the regulator is hopeful of a turnaround in fortunes for the nascent pension scheme. PFRDA's official spokesperson said, "From our interaction with the PoPs (points of presence), we learnt that the EET status was one of the biggest roadblocks in the growth of NPS. This was especially true among the discerning subscribers. When they compared NPS to other products, they found it lacking in this particular aspect. Now that this change has been proposed, we are hoping for more interest from the public."

Speaking about the next course of action, the spokesperson said, "The only obstacles we were facing were with the EET status and the lack of awareness. The first hurdle has now been addressed. Now we need to create awareness among the masses about this product. Hopefully, this issue of lack of awareness will be resolved with the media plan we are currently working on. We are in the process of appointing a media agency. Now that we have a permanent chairman, surely things will move much faster."

Hemant Rustagi, CEO of Wiseinvest Advisors, said, "There could be an initial adverse reaction from mutual fund investors. But they will have to realise that equities still remain the best bet for long-term wealth building. The returns could be lower because of taxation, but for someone who looks at the long-term horizon, it shouldn't matter much. More and more people now invest in an SIP; so the intent is to stay invested for the long term."