Finance Bill 2023: Debt mutual funds to lose tax advantage, bank FDs may gain

MUMBAI: Debt mutual funds are set to lose tax advantage as the government has proposed to treat capital gains arising from them as short-term capital gains and would be taxed at an individual’s relevant tax slab.
According to the proposed amendment in the Finance Bill 2023, any income from mutual funds in which less than 35% of the holding is in Indian equities (mainly debt mutual funds), if the investment is done after 1 April 2023, will be classified as short-term capital asset irrespective of the period of holding.

Investors preferred debt funds over fixed deposits owing to its tax advantage. Debt fund investors pay income tax on capital gains according to their tax slab for a holding period of three years, and after that, they are taxed at the rate of 20 per cent with indexation benefits or 10 per cent without the benefits.

Apart from debt funds, the proposed changes will also impact international funds and gold funds. Bank fixed deposits will be the major beneficiaries of the proposed changes as both debt funds and bank fixed deposits will be subject to the same taxability of maturity proceeds.

“According to the proposed amendments to the Finance Bill 2023, debt mutual funds may no longer receive indexation benefits and will be taxed at marginal rates. This will also affect gold funds and international funds. This move may have a negative impact on all debt funds, particularly in the retail category, as ultra-high net worth and high net worth individuals may choose to invest in safe havens like bank fixed deposits,” said Manish P Hingar, Founder of Fintoo.

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“We may see a shift from long-term debt funds to equity funds, and money may be directed towards sovereign gold bonds, bank fixed deposits, and non-convertible debentures in the debt category. 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,” he added.

The proposed changes, once approved by the parliament, would be applicable to investments made on or after April 1, 2023.

“Last 1-2 years, MF have seen outflows from debt schemes, in spite of the tax benefit. The only segment that saw inflows was the spate of target maturity funds which were passively holding Gsecs, mimicking FDs but with tax benefits. Investors may be reluctant to redeem even after completion of 3 years now as incremental income from these investments may remain tax efficient,” Sandeep Bagla, CEO, Trust Mutual Funds told TNIE.

“Few investors may remain invested wanting to defer tax, as tax is payable only at redemption. Incremental inflows will come into funds that are able to manage their portfolios actively and generate inflation-beating returns for investors. There is likely to be no impact in the short term but could impact the ability of mutual funds to attract debt flows in the long term,” he added.