The Association of Mutual Funds in India (AMFI) has urged the government to reinstate the indexation benefits for debt mutual fund schemes, a key tax advantage that was withdrawn in 2023. This plea was reiterated by AMFI’s CEO, Venkat N Chalasani, during the India Fintech Forum’s IFTA 2024 event held on December 12. The move comes in the wake of changes to the tax regime for debt mutual funds, which have impacted the appeal of these investment instruments for risk-averse investors.
Taxation Changes Affecting Debt Mutual Funds
Prior to April 1, 2023, long-term capital gains (LTCG) from debt mutual funds—investments held for over three years—were taxed at 20% after availing the indexation benefit. Indexation allowed investors to adjust the purchase price of their investments based on inflation, thereby reducing taxable gains and lowering the overall tax liability.
However, amendments to the Finance Bill in March 2023 removed this indexation benefit for debt mutual funds acquired on or after April 1, 2023. Consequently, capital gains from these funds are now taxed as per the investor’s income tax slab, irrespective of the holding period.
Latest Tax Developments in the July 2024 Budget
Further changes were introduced in the capital gains taxation framework in the July 2024 budget. From July 23, 2024, LTCG from the sale of all assets, including listed and unlisted securities, are taxed at a flat rate of 12.5%, but without the indexation benefit.
Debt mutual funds, however, were exempted from this revised rate structure. Gains from these funds continue to be taxed based on the investor’s income tax slab, regardless of the duration of holding. Notably, debt mutual funds purchased before April 1, 2023, are now taxed at the revised LTCG rate of 12.5% but no longer enjoy the indexation benefit.
Implications for Investors
These taxation changes have significantly altered the attractiveness of debt mutual funds, especially for long-term investors who previously benefitted from reduced tax liabilities due to indexation.
- For Funds Purchased Before April 1, 2023:
- Gains from funds sold after July 23, 2024, will be taxed at 12.5% as LTCG.
- The indexation benefit, which helped lower taxable gains, is no longer available, potentially increasing tax liability.
- For Funds Purchased On or After April 1, 2023:
- All capital gains are taxed as per the investor’s income tax slab, regardless of the holding period.
- This removes the distinction between short-term and long-term capital gains, making debt mutual funds less tax-efficient for high-income investors.
Why AMFI Seeks Indexation Reinstatement
AMFI’s CEO, Venkat N Chalasani, emphasized the importance of indexation in making mutual funds an attractive investment option. Debt mutual funds traditionally cater to risk-averse investors, offering steady returns through investments in fixed-income securities like bonds, treasury bills, and commercial papers. The removal of indexation has made these funds less competitive compared to other fixed-income instruments, such as bank fixed deposits or government savings schemes.
“Restoring indexation benefits will encourage more people to invest in mutual funds,” Chalasani stated, highlighting that this could widen financial inclusion and enhance the mutual fund industry’s growth.
Broader Economic Impact
The changes in taxation policy have raised concerns about the government’s approach to promoting investment in debt mutual funds. Critics argue that the elimination of indexation benefits and the preferential tax treatment for other asset classes could skew investor preferences away from debt funds, affecting the flow of funds into India’s debt markets.
Moreover, these changes come at a time when global economic uncertainties and inflation concerns have increased the importance of fixed-income investments. Debt mutual funds provide critical support to corporate and government bond markets, enabling infrastructure development and economic growth.
Conclusion
The taxation policy for debt mutual funds has undergone significant revisions over the past two years, altering the landscape for investors. While the government’s move to streamline the tax regime aims to simplify compliance, the lack of indexation benefits has dampened the appeal of debt mutual funds for long-term investors.
AMFI’s call to reinstate indexation benefits underscores the need to strike a balance between tax efficiency and investment attractiveness. With the Union Budget 2025 approaching, it remains to be seen whether the government will address these concerns and create a more favorable tax environment for mutual fund investors.
