Explained: How Centre’s Move To Tax Gains From Debt Funds Will Affect You

The Centre is contemplating removing long-term tax benefits for debt mutual funds. It has proposed to tax investments in debt mutual funds as short-term capital gains through amendments to the Finance Bill 2023. According to the proposed move, mutual funds in which less than 35% of investment is made in equities will be treated as short-term. The indexation benefit in such funds will also be removed, which is likely to increase the tax burden on investors.   

What are debt mutual funds?

According to the Association of Mutual Funds in India, a debt fund is a mutual fund scheme that invests in fixed-income instruments such as corporate debt schemes, government and corporate bonds, money market instruments, and corporate debt securities.

How are debt mutual funds taxed currently?

Debt funds that are held for more than three years are subject to tax as per the investor’s income tax slab. For a holding period of more than three years, investors need to pay 20% tax with indexation or 10% tax without indexation on the gains arising from debt funds.

What is the indexation benefit?

Indexation reduces the tax liability for the investors as the tax is calculated after taking inflation into consideration. The government has now proposed to do away with this benefit. Once the move comes into effect, debt funds will be taxed on par with fixed deposits. Even long-term capital gains from debt funds will be taxed as short-term capital gains.  

What impact will it have?

According to experts, the proposed move will impact the elderly and corporates, and those people who are wary of investing in equities and take a higher financial risk. It could also give a push to bank deposits that have witnessed slow growth as compared to credit demand in the past 12 months.

Investors are likely to start preferring fixed deposits over debt funds once the indexation benefit is gone. “The proposal would take away the tax advantage for such funds and the investors may resort to alternate options such as fixed deposits,” Amit Maheshwari, tax partner, AKM Global told the Financial Express.

According to Gaurav Rastogi, CEO & founder at Kuvera.in., the move “will lead to an increase in the yield on corporate debt for investors to get the same after-tax returns”, reported CNBC-TV18.