India has proposed to tax investments in debt mutual funds – funds where not more than 35 percent is invested in equity shares – as short-term capital gains, eliminating the long-term tax advantages that made such investments appealing to investors.
The suggested changes have been included in the Finance Bill introduced by FM Nirmala Sitharaman.
The proposed changes imply that the indexation benefits that help reduce tax liability considerably for such funds as they account for inflation may be removed.
As a result, the tax rate applicable would be determined by the income tax slab in which the investor falls. This could reduce inflows into debt mutual funds and benefit bank deposits.
At present, investors in debt funds pay income tax on capital gains according to the income tax slab for a holding period of three years. After three years, these funds pay either 20% with indexation benefits or 10% without indexation.
The proposed changes, if approved by the Parliament, would be implemented on investments made on or after April 1, 2023.
"Debt mutual funds had a favourable tax regime as compared to banks' fixed deposits and small savings," Amit Maheshwari, a tax partner at AKM Global, told Reuters, adding now debt mutual funds will be taxed at par with other investments. "This could impact debt mutual funds' investments in corporate bonds."
This proposed move is targeted mostly towards high net-worth individuals who were using this investment as a tax-saving instrument, Maheshwari added.