Synopsis
The mutual fund (MF) industry is advocating for tax relief on capital gains from debt-oriented mutual funds (MFs), particularly the restoration of indexation benefits that were removed in the Finance Bill 2023. This change is being considered by the government and may be announced in the upcoming Budget FY26. The industry argues that the current tax structure has made debt MFs less competitive compared to fixed deposits, primarily due to rising inflation and stagnant real returns.
Take a look at important historical data
- Current Tax Structure: As of April 2023, debt MFs are taxed at the investor’s income tax slab rate, which has increased the tax burden significantly. The previous structure allowed for a more favorable tax treatment for long-term investors.
- Historical Context: The indexation benefit was previously available for long-term capital gains, allowing investors to adjust their capital gains for inflation, thus reducing their taxable income. The removal of this benefit has been viewed as detrimental to the growth of the debt fund market.
- Market Data: As of November 30, 2023, the total assets under management (AUM) for debt funds stood at Rs 16.86 lakh crore, a significant increase from Rs 12.57 lakh crore a year earlier. In contrast, gold ETFs saw a rise from Rs 20,832.77 crore to Rs 44,244.82 crore in the same period.
- Industry Perspective: Experts like Anurag Mittal from UTI MF emphasize the importance of encouraging retail investors to invest in debt funds, particularly as the bond market in India is still developing. Neeraj Agarwala from Nangia & Co also highlights the need for reinstating indexation to restore investor confidence and ensure tax equality.
In Short
- Restoration of Indexation Benefits: The MF industry is pushing for the reintroduction of indexation benefits for calculating capital gains on debt MFs, which were withdrawn earlier this year.
- Alignment of Tax Rates: There is a call for aligning the long-term capital gains (LTCG) tax rates of debt MFs with those of listed bonds, proposing a tax rate of 12.5%.
- Impact of Recent Tax Changes: Since April 2023, capital gains from debt MFs are taxed at the investor’s income tax slab rate, leading to increased tax liabilities.
- Investor Confidence: The withdrawal of indexation benefits has created tax uncertainty, potentially deterring new investments in debt MFs.
- Comparative Performance: Over the past few years, debt funds have offered modest returns, which have been adversely affected by inflation, resulting in low real returns for investors.
Concerns of Mutual Fund Industry & AMFI, In Detail
Restoration of Indexation Benefits
The mutual fund industry is advocating for the restoration of indexation benefits, which adjust the cost of capital assets for inflation. This benefit was removed in the Finance Bill 2023, leading to a decline in the attractiveness of debt MFs compared to fixed deposits. The industry argues that the reintroduction of indexation is crucial for ensuring that returns on debt funds remain competitive.
Alignment of Tax Rates
The MF industry has requested that the government align the LTCG tax rates for debt MFs with those applicable to listed bonds. Currently, the industry is pushing for a tax rate of 12.5% for long-term investments held for over a year. This change is expected to enhance the appeal of debt MFs, making them a more attractive option for investors.
Impact of Recent Tax Changes
Since April 1, 2023, capital gains on debt MFs have been taxed at the investor’s income tax slab rate, irrespective of the holding period. This shift has increased tax liabilities for investors in debt funds. Previously, LTCG on debt MFs was taxed at either 20% with indexation or 10% without it. The change has left investors feeling the pinch, as the tax burden has increased significantly.
Investor Confidence
The Association of Mutual Funds in India (Amfi) has expressed concerns that the removal of indexation benefits has led to tax uncertainty. This uncertainty could deter new investors from entering the capital markets through MFs and discourage existing investors from making further investments. The industry believes that reinstating indexation benefits would restore investor confidence and promote tax equality among various financial instruments.
Comparative Performance
Over the last three to five years, debt funds have delivered returns of around 7%, while inflation has hovered around 5.5%. This discrepancy means that the real income earned by debt fund investors is only about 1.5%, which is not attractive compared to other investment options. The MF industry argues that without competitive returns, investors may choose to move their funds to fixed deposits or other safer instruments.
Final Takeaways
The mutual fund industry is making a strong case for tax relief on capital gains from debt MFs, with a focus on restoring indexation benefits and aligning tax rates with listed bonds. The current tax structure has increased liabilities for investors and diminished the attractiveness of debt funds. The industry believes that reinstating these benefits will not only enhance investor confidence but also encourage more individuals to invest in debt MFs, thereby promoting the growth of this sector in the Indian financial market. As the government considers these proposals, the outcome could significantly impact the mutual fund landscape and investor
