Debt mutual funds to lose LTCG benefit: Should you still invest? Should you rush before financial year ends?

Investors that used the tax arbitrage to maximise gains will now have to look at gross returns, instead of post-tax returns.

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The proposed amendments will have a major impact on the taxation of gains on various types of mutual funds.

A proposed government amendment seeking to remove Long Term Capital Gains Tax benefit from debt mutual funds, gold funds, international fund of funds, etc will prompt debt investors to now weigh their decisions entirely based on gross return and merit, instead of tax arbitrage. The government has reportedly introduced an amendment in the Financial Bill for the upcoming financial year 2023-24, which will treat all gains, from mutual funds that have less than 35% of money in equity, as short term capital gains. The Bill will be tabled in the Parliament today, and if approved, this rule change will apply to investments made from 1 April 2023 onwards. At present, long-term capital gains on debt funds are taxed at either 10% without the indexation benefit or 20% with the indexation benefit.

What should debt investors do? Is there a merit to investing in debt mutual funds now?

Investors that utilised the tax arbitrage to maximise gains will now have to look at gross returns, instead of post-tax returns, Niranjan Avasthi, Sr VP & Head, Edelweiss AMC, told Once all FDs, debt mutual funds and Market Linked Debentures are taxed at parity, the primary benefit of debt mutual funds dissipates. However, this doesn’t mean debt mutual funds will be made entirely unattractive. Investors will flock to whichever asset offers better returns now, he said. The focus will pivot to factors such as FD interest rates and repo rate, regardless of the asset itself.

Short term debt mutual funds investments unaffected; long term investments may still have a few advantages

The change makes little difference to short term investments in debt, gold or other types of mutual funds other than equities for less than three years; such investors would continue to park their money in liquid funds, Prableen Bajpai, founder, FinFix, told Until further notice, it should be assumed that the gains on this will be classified as STCG, which allows it to be set off against capital loss, instead of income tax, she added. Unlike FDs, debt mutual funds also offer the benefit of paying tax only at the time of redemption, which will hopefully not be erased.

On the other hand, investors looking for long-term savings will be adversely impacted, since there are no inflation-beating or inflation-matching instruments accessible to investors anymore. Debt funds reward investors with indexation benefit, but will now have to compete with bank deposits and corporate FDs, which doesn’t offer investors any additional reward for assuming risk, Prableen Bajpai said, adding, “It’s hard to understand the move.” She added that disincentivizing long-term savings is a poor move; both equity and debt need to have some benefit for investors.

Should investors rush to debt mutual funds before 31 March for tax benefit? How this impacts financial planning for FY23, and beyond

Since the new amendments are set to impact mutual funds with lower than 35% in equity from 1 April onwards, as a financial advisor, Bajpai said she wouldn’t state that an investor rebalance their assets just for the sake of taxation benefits. However, if an investor with sufficient capital was already looking to add money to fixed-income, she suggested that they should invest sooner, rather than later.

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First published on: 24-03-2023 at 11:59 IST