The latest amendment to the Finance Act proposes to remove the benefit of indexation and long-term capital gains (LTCG) for non-equity mutual funds. The proposed amendment is likely to bring debt funds in line with fixed deposits (FDs). The new rule will come into force from April 1, 2023.
As per the proposed amendment, the debt funds which are purchased after April 1, 2023 and sold after three years, the gains accrued will be treated as short-term capital gains and will be added to the taxable income. Until now, they were considered as long-term capital gains (LTCG) and after indexation, a 20 percent tax was levied.
So, once the new rules take effect, taxpayers falling under the maximum tax bracket will be liable to pay 30 percent income tax instead of 20 percent which is applicable in the current scheme of things.
To make matters worse, the wording of the amendment implies that it will apply not only to debt mutual funds, but to a wide variety of mutual funds since it only excludes the mutual funds with more than 35 percent assets under management invested in equity. This effectively means this will also include gold ETFs, international funds, and some hybrid funds.
What experts say
Financial experts opine that this will have an adverse impact on debt mutual funds and investors’ gains.
Edelweiss Mutual Fund's MD and CEO Radhika Gupta says, “If this were to be passed, the impact will be adverse on a number of categories of mutual funds. It covers any mutual fund that holds less than 35 percent in equity's share. It means all debt mutual funds, it means gold ETFs, international funds, even select hybrid funds. The ambit is truly wide.”
She also adds: “Debt funds will be significantly less attractive to consumers versus traditional instruments. We are a nation of savers and debt is an important part of people's asset allocation.”
About the larger impact of this amendment, Ms Gupta says, “They are one domestic institutional investor which is not held to maturity unlike insurance and EPFO. After all, liquidity from corporate bond markets comes from mutual funds.”
Anant Ladha, financial expert, says that this is bad for investors as the indexation benefit will be removed. “This will kill debt funds. And will bring parity between FD and debt funds. The removal of indexation benefit from debt mutual funds is a big loss for bond markets that are still struggling with liquidity,” he says.
However, some are optimistic and believe that debt mutual funds will continue to be better than fixed deposits.
Vashishtha Iyer, Chief Operating Officer of Capital Minds, argues that debt mutual funds will still be better than fixed deposits (FDs) because they have an ability to offset capital gains versus losses and they follow the first in first out principle.
“This is a good move. Taxes across asset classes should be homogenized. A lot of investors under-price credit risk and invest in corporate debt over FDs enamored by the favorable taxation,” says Gaurav Rastogi, CEO & founder, Kuvera.in
At the same time, some believe that the proposed amendment implies a smaller scope of mutual fund schemes.
“Another interpretation of the amendment implies a much smaller ambit of mutual fund schemes. This is an amendment to a clause that relates to MLDs and mentions specified mutual fund schemes,” says SBI Mutual Fund's Deputy Managing Director DP Singh.