Tax setback for debt mutual funds: What investors can do now?

On Friday, the government amended the mutual fund rules in Finance Bill 2023, wherein debt mutual fund investors will no longer receive a tax benefit on long-term capital gains after April 1.

The change in the tax treatment on debt mutual funds comes into effect after the Lok Sabha passed the Finance Bill 2023 on Friday without any discussion on the 64 amendments to the country’s direct and indirect tax regime that were introduced through finance minister Nirmala Sitharaman’s budget on February 1. The Budget is yet to be passed in the Rajya Sabha.

As per the new amendment to finance bill 2023, no benefit of indexation for the calculation of long-term capital gains on debt mutual funds will be available for investments made on or after April 1, 2023, where equity investments in such schemes do not exceed 35%. Thus, from April 1, 2023, these debt mutual fund schemes will be taxed at income tax rates applicable to your income. This brings taxation parity between 100% debt mutual fund schemes and bank fixed deposits.

What investors can do now?

Most investors prefer investing in debt mutual funds as compared to bank fixed deposits because there is a tax advantage.  From April 1, 2023, no such tax benefit is available. Hence, these debt funds may have to modify the structure with the enhancements of equity instruments with more than 35% of equity investments in their portfolio to retain the investors. This is because only those debt mutual funds will lose long-term capital gain benefits where equity investments in such mutual funds do not exceed 35%.

Alternatively, investors who do not risk investing in equity funds may directly invest in debt instruments and save charges of Mutual Funds.

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