Corporate appetite for debt funds likely to wane

Currently, debt fund investments of over three years qualify for long-term capital gains tax.

debt mutual funds, mutual funds, finance bill, finance bill 2023
Typically, corporates invest across debt mutual fund categories depending on their need.

The government’s latest move to remove the indexation benefit for debt mutual funds available for over three years may dent the corporate appetite for these schemes. This, in turn, will push them to look at alternative investment avenues, say experts.

“Maybe the government wanted to bring mutual funds on par with fixed deposits. That may be the logic in imposing this. Mutual fund is an avenue as far as corporates are concerned to reduce their tax burden. In my view, they have to relook the overall routing of funding by corporates through mutual funds. At the same time, mutual funds are reinvesting this money into capital intensive activities that will encourage capital investment in India,” Seshagiri Rao, joint managing director and group chief financial officer, JSW Steel, said to a television channel.

Added R Shankar Raman, CFO, L&T: “Quite obviously, it will impact the post tax returns on such investment. Most corporates, however, park their short-term surpluses in other than duration debt funds. Impact on retail investors will be sharper in my view.”

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. As per the amendment, those debt funds will lose the indexation benefit where equity investments in such schemes do not exceed 35%.

Currently, debt fund investments of over three years qualify for long-term capital gains tax. Their gains are taxed at 20% with indexation benefits or 10% without indexation benefit. Investors pay income tax at slab rate on investments of less than three years.  

Nitan Chhatwal, MD, Shrem Infrastructure, said: “The change in tax status of debt funds has brought funds at par with bank fixed deposits. Big corporate investment in these schemes will reduce as tax advantage has gone. It will help banks take advantage and increase deposits.”

Typically, corporates invest across debt mutual fund categories depending on their need. There are corporates who invest in schemes with a term of more than three years like target maturity funds. With the change in taxation norms, they will have to weigh their investment options.

“Corporate interest in debt mutual funds will be impacted. If you see for mutual funds and equity, if you are not getting tax benefit or they are not going to give advantages for three years, mutual fund industry will definitely get impacted,” Vedant Goel, managing Director, Neo Mega Steel, said.

Instead of pure-play debt funds, corporates will likely lock into hybrid funds to offset losses on other instruments, say fund managers. “The bond market across the globe is already in turbulence and this unexpected amendment has come as a shock to the industry. It may be possible that the corporate bond market trading may be largely muted till financial year and the yields may start raising from April if investors start withdrawing funds from debt MFs,” Venkatakrishnan Srinivasan, founder and managing partner, Rockfort Fincap, said.

“Post withdrawal of long-term capital gains benefits, investors may tend to look for fresh investment options to derive higher yields. Hence, lower credit-rated funds giving higher yields may take off again or the investments in AIF industry should increase. Public issue of bonds may increase as investors may prefer to directly tap the bond market.

“Debt funds may have to modify the structure with the addition of equity instruments in their portfolio, and that too more than 35% of equity investments in their portfolio to retain long-term capital gain benefits and also to retain their investors,” he added.

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First published on: 25-03-2023 at 07:51 IST
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