There are some risks related to investing that are not widely talked about but which, I believe, one would do well to take note of. One such risk is that of a change in tax laws (some consider this as part of what is known as, “regulatory risk”). In a way, the recent Budget proposals to amend the way gains from debt funds are taxed, have put this risk in the spotlight. In this post, I propose to offer my thoughts on this risk.
Tax benefits can come at three levels – on the amount we invest, on the dividends we get, and on the gains we make (or the amount we get) when we exit. A change in tax laws that may adversely affect the latter two is what we most need to watch out for. Depending on the nature of such a change, one may end up having to pay far more taxes than one planned for, or worse, the achievement of a financial goal may be in jeopardy. Consider the recent proposals, for instance. Someone who invested in an FMP with a tenure of less than 3 years could well end up paying 3 times the amount of tax originally envisaged, or even more (unless, of course, the fund house is able to extend the tenure of the fund). On the other hand, what if, this amount was needed to fund a financial goal that cannot be deferred, such as one’s child’s higher education?
History provides us enough evidence of the unpredictability of tax laws. Once upon a time, all long term gains (including those from equities) were defined and taxed in the manner that has now been proposed for debt funds. Till 1999, dividends were taxable. Some of these changes have been pleasant, some not so. Some proposals never advanced beyond being proposals. But at no point, was there any way of knowing for certain what would happen in the future. It remains to be seen as to whether the current proposals will become a reality and, if so, in what shape. Time will tell what other changes may happen. Given that this risk may not be identical across all kinds of investments, makes a case for diversification. As I suggested in an earlier post, diversification can minimize the impact of unpleasant surprises that may affect any single investment or category of investments.
Investing is always fraught with uncertainty. There are very few, if any, assurances that can be said to be carved in stone. Taxes, too, as history shows, aren’t quite the certainty that some have suggested.
