The mutual fund industry is seeking the same tax status for debt schemes as it exists for equities in the upcoming Union Budget. The industry believes that since the government is trying to deepen the bond market, it would be a strong statement to attract retail money into debt schemes.
Currently, capital gains on debt mutual funds are taxed at marginal slab rates (10%-30%+ cess) regardless of the holding period. The industry is asking for parity with listed bonds, where long-term capital gains are taxed at 12.5% after a 12-month holding period.
Parity with Listed Bonds
Venkat Chalasani, chief executive, Association of Mutual Funds in India (AMFI) said that the industry has requested for an amendment to Finance Act, 2023 and consider the mutual fund units as “securities”, with long-term capital tax rate thereon should be according to / in line with the capital gains tax on listed bonds.
Further, debt mutual funds are a vital investment class for conservative investors, particularly senior citizens, who rely on them for income stability. “The current tax treatment is viewed as disproportionately affecting this demographic,” he explained.
Anurag Mittal, head of fixed income, UTI AMC said both the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (Sebi) have highlighted the need for a well functional corporate bond market and mutual funds are big participants in ensuring the volumes, price discovery, and innovation.
“We believe that investors should be given an option,” he said as the arbitrage between investing directly in bonds and through mutual funds should be normalised as the latter offers a diversified, more informed portfolio and better management of credit risk. “If implemented, this will help reduce the risk of any mishaps in the initial stages of developing the bond market,” he said.
Indexation and DLSS
Apart from this, restoration of long-term Indexation which was withdrawn in Budget 2024, correction of retrospective impact of withdrawal of indexation, and introduction of debt-linked savings schemes (DLSS) are also among the suggestions of the industry.
For indexation, Chalasani explained that debt funds typically yield returns of 6% to 8%, and with the 10-year average consumer price inflation around 5.5%, the real income for investors is only approximately 1.5%.
“Indexation incentivises long‑horizon fixed‑income saving and restores parity with other long‑term assets, like real estate which recently saw a restoration of indexation benefits,” he said.
He also pointed out retrospective withdrawal of indexation for investments made before March 31, 2023 as a key concern. “Restoring the Indexation benefit on long term capital gains from debt funds will boost the confidence of retail investors in the Indian Debt Market,” he said.
Tejas Desai, Partner and Tax Financial Services Leader, EY India, added that the market will get some fillip if debt schemes investors also get similar exemption of zero tax up to Rs 1.25 lakh annually. Currently, it applies only to equity-oriented assets (those with at least 65% invested in domestic equities) that are held for more than 12 months.
According to Chalasani, a vibrant corporate bond market is also important from an external vulnerability point of view, as a dependence on local currency and markets will lower risks. He also said that the industry has proposed a DLSS (debt linked savings scheme), much like the ELSS (equity linked savings scheme) with a 5-year lock-in and a separate tax deduction, to help broaden the retail base in the bond market.
This will provide an alternative fixed income option with tax breaks to retail investors and help retail investors to participate in bond markets at low costs and at a lower risk as compared to equity markets. This will also bring debt-oriented mutual funds on par with tax saving bank fixed deposits, where deduction is available under Section 80C, he said.
Kaustubh Gupta, CIO – Fixed Income, Aditya Birla Sun life AMC Ltd, said: “For an asset allocation perspective, investment decisions should be driven by the risk appetite and investment objective of an individual investor but with differential taxation, investment flow has changed significantly in favour of equities.”
He believes that this increased focus on equities has resulted in rising valuations. Hence, there is a need to re-look the policy regime that is neutral across asset classes.