Modi Government’s surprise tax move introduced via amendments to the Finance Bill 2023 is set to boost some investment avenues. As per the changed rules, debt mutual funds that do not have more than 35% of their AUM invested in equity will no longer enjoy long-term capital gains. From 1st April onwards, income from such funds will be treated as short-term capital gain and taxed at the investor’s slab rate.
Not just debt funds, capital gains from international funds, gold funds (like Gold ETFs), hybrid funds and even domestic equity funds of funds (FoFs) that do not invest more than 35% in equity will also be taxed at an individual’s relevant tax slab.
“This is perhaps one of the biggest taxation changes proposed in the last few years that will impact your fixed-income investments. As an amendment to the finance bill, it is proposed to change the taxation of mutual funds with less than 35% holding in equities,” says Akshar Shah, Founder and CEO at Fixed.
“These funds will now be taxed as short-term capital gains irrespective of their holding period. Simply put they will be taxed at your slab rate,” he adds.
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The new tax rule will bring bank fixed deposits at par with debt mutual funds. Experts say that with the removal of arbitrage between different debt instruments, the new tax rule may boost bank FDs.
“The proposal will bring bank fixed deposits (FDs) on par with debt MFs. This move will likely give a boost to bank FDs and bonds and will do away with the arbitrage between different debt instruments,” says Saurav Basu, Head of Wealth Management, Tata Capital.
“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,” says CA Manish. P Hingar, Founder at Fintoo.
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Equity Mutual Funds
Experts say that the removal of LTCG benefits on debt funds may result in a movement of funds towards equity/growth mutual funds. “We may see a shift from long-term debt funds to equity funds,” says Hingar.
“The industry may also see a shift of money from long-term debt funds to equity-oriented funds due to taxation benefits. The change will not affect Corporates or HNIs who invested in debt MFs for a shorter period (less than 3 years),” says Basu.
Sovereign Gold Bonds
The new tax move will take away the sheen from gold ETFs and make Sovereign Gold Bonds more attractive. Experts say that more money may now be directed towards sovereign gold bonds (Read more)
According to tax experts, physical gold investors will continue to benefit from LTCG tax at 20% with indexation, which applies when the Gold is sold after three years of purchase.
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Corporate bonds may also benefit from the new tax rules due to renewed interest from retail investors.
“The amendment in the finance bill will have significant structural changes to the way we invest. For mutual funds to get investor interest, it’ll now have to purely be on their ability to add extra ‘risk-adjusted returns’ and not because of any tax arbitrage,” says Srikanth Subramanian, CEO, Kotak Cherry.
“The tax arbitrage that was available at an ‘instrument-level’ seems to be getting evened out across the board be it debt MF or MLD. However this will benefit the corporate bond market where there will be renewed interest from retail investors, and this will also add depth to the liquidity which again will mean better pricing for the end customer,” he add.
Somnath Mukherjee, CIO and Senior Managing Partner at ASK Private Wealth says, “Removing tax arbitrage from all categories of fixed income is good for the development of bond markets in general, corporate bond markets in particular. It will incentivise a larger pool of retail investors to directly participate in the debt markets – both G-Sec and corporate bonds, instead of getting intermediated via wholesale platforms like Mutual Funds. It will also force debt MFs to work harder on generating alpha, and bring down costs of passive MFs like Target Maturity Funds, Roll-down Funds and FMPs.”
“Equalisation of tax between bank FDs, MFs and Bonds also gives greater choice to investors to select from a wider pool of instruments, depending on their risk appetite, investment amount and investment objectives. Instead of being nudged purely by a large tax arbitrage in one instrument skewing the choice,” he adds.