Introduction: –
Debt funds are mutual funds that invest predominantly in debt instruments that provide fixed-income like government securities, corporate and government bonds, money market instruments, etc.
The principal objective of these mutual funds is to offer relatively stable returns, making them perceived as low-risk investment alternatives when compared to equity mutual funds or hybrid funds which primarily allocate assets into equities.
As a result, debt funds stand out as the favoured investment option for individuals seeking a dependable source of passive income.
Taxation of Debt Mutual funds before 1st April 2023
As per the provisions of the Income Tax Act, 1961, the gains from the sale of debt mutual funds are considered to be
Short-Term Capital Gains: If the debt mutual fund unit is sold within 36 months (three years) of purchase, the gains are termed short-term capital gains (STCG). These short-term capital gains were taxed at slab rates.
Long-Term Capital Gains: If they were sold after 36 months, then the gains were termed long-term capital gains (LTCG). These long-term capital gains were taxed at 20% with an indexation benefit or 10% without indexation. Indexation benefit means the gains made by investors were adjusted for inflation.
Taxation of Debt Mutual funds after 1st April 2023
The Finance Minister on 24th March 2023, announced an amendment to the Budget 2023 in the capital gains tax on debt funds which will be applicable from 1st April 2023.
As per this amendment, LTCG on debt mutual funds will no longer have the benefit of indexation. Therefore, debt mutual funds will now be taxed at the applicable slab rates.
Moreover, indexation benefits will not be available for LTCG on gold mutual funds, hybrid mutual funds and international equity mutual funds.
Consequently, mutual fund houses are likely to be adversely affected as investors may prefer to invest directly in debt securities rather than debt mutual funds to avoid AUM fees/charges.
The change may also impact the attractiveness of these mutual funds as an investment option, as the tax burden on the profits may increase.
Impact of the proposed changes
The recent changes have sent a shock wave across the debt market and especially for retail investors.
Experts believe that this move will crash the debt market in the country as the returns will no longer be as attractive for the common investors. This move will bring the returns from debt mutual funds at par with the bank FDs.
Many believe that this will provide a push for the bank deposits that have not risen as much as the credit demand in the past 12 months.
Investors will likely prefer the less risky investment options like fixed deposits as there will be no tax exchange and this may lead to less inflow of funds towards debt mutual funds.
These funds will therefore have to rely purely on their ability to provide better risk-adjusted returns to attract investors and make investments in debt mutual funds profitable.
Conclusion
The proposed changes in the taxation of debt mutual funds will be tolled into effect from 1st April 2023 and which will bring them in line with FDs and NCDs.
The corporate bond market may gain from the proposed but mutual funds houses focusing on fixed-income mutual funds may face a negative impact.
Investors, however, have the chance to continue to reap the benefits of indexation by investing in debt mutual funds before 31st March 2023.
Author:
Khushi Shah | Associate Consultant | Email: blogs@masd.co.in
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