Debt mutual funds that do not have more than 35% invested in equity shares of domestic companies will no longer enjoy the long-term capital gains benefit. The amendments to the Finance Bill, 2023, passed by the Lok Sabha, have said such funds will now be taxed at the income tax slab level and will be treated as short-term capital gain at the taxpayer’s slab rate, just like bank deposits.
As a result, bank fixed deposits will become more attractive, as both debt funds and bank fixed deposits will be subject to the same taxability of maturity proceeds. Even gold funds and international funds will lose the long-term capital gains tax benefits.
The new amendments will be applicable to funds acquired on or after April 1, 2023, and will not impact mutual funds acquired before April 1, 2023. Those funds will still be taxed as long-term capital gains if the holding period is more than 36 months.
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At present, debt mutual funds held for more than three years are treated as long-term investments and taxed at the rate of 20% along with indexation benefits or 10% without indexation. If the holding period is less than three years, then they are taxed at the slab rate of the investor. This provided a tax arbitrage opportunity, allowing investors to pay a lower rate of tax if they held onto the investment for more than three years.
Neeraj Agarwala, partner, Nangia Andersen India, said there will be no incentive for a taxpayer to hold debt funds for a period of more than 36 months to avail of the benefit of indexation and lower tax rate. “Now, the taxation of debt funds will be the same irrespective of the holding period.”
The change in debt taxation would meaningfully impact allocation decisions. Roopali Prabhu, chief investment officer & executive director, Private Wealth Group, JM Financial, said for the same expected return, investors will now have to take higher risk. “Assuming an investor’s target return was post tax 7% per annum over three years, that is currently achievable by investing 100% in a target maturity fund that invested in AAA papers. Going forward, assuming yields don’t change, the investor will have to invest over 25% in equities (assuming 13% equity return) to achieve the same target return.”
Experts say as there is no change in short-term capital gains for debt funds (holding period less than three years), individuals can continue to invest in liquid funds to earn higher post-tax returns than parking money in savings bank accounts.
Harshad Chetanwala, co-founder, MyWealthGrowth.com, said, “Earlier, too, the tax on such investment was as per the tax slab and it continues to be the same. This will not affect the purpose of investing in debt funds from a short term perspective,” he says.
“Investors are likely to find fixed deposits a more safe option considering the tax arbitrage is lost now. As a result, the banking sector can look at attracting the customers with higher interest rates on FDs,” says Amit Maheshwari, tax partner, AKM Global
Adhil Shetty, CEO, Bankbazaar.com, says the changes in debt mutual funds should bring parity between fixed deposits and savings accounts, essentially by removing tax efficiency. “Without the tax efficiency, people may prefer to keep their money in bank deposits.”
