Finance Bill proposes removal of tax advantage for debt mutual funds

Finance Bill

Long-term capital gains (LTCG), which were previously taxed at 20% with an indexation benefit, will no longer be advantageous to debt mutual funds starting on April 1, 2023.

A few changes have been suggested for the Finance Bill. One such modification is that investments in mutual funds, which are essentially debt funds and have up to 35% equity exposure to domestic companies, are subject to taxation at the investor’s income tax slab rate.

With capital gains added to the investor’s income and taxed at his or her slab rates, debt funds now receive the same tax treatment as other bank fixed deposits.

As a result, an investor will now be taxed according to his or her tax bracket regardless of how long they have held a debt mutual fund (LTCG was previously applicable after three years). Investors who are subject to the highest income tax rate of 30% must pay 35.8% of their gains (including surcharge and cess) out of pocket, with no indexation benefit.

According to specialists in the field, this would affect both investor flows into debt mutual funds and the overall bond market. “Mutual funds offered liquidity in the local bond market, which is otherwise highly illiquid. Niranjan Avasthi, head of product, marketing, and digital business at Edelweiss Asset Management, notes that investor flows into debt mutual funds were invested in the bond markets.

According to Kirtan Shah, founder and CEO of Credence Wealth, “This decision affects not only debt MFs but also international funds and gold funds.”

A target maturing fund earlier may have provided a post-tax yield of 7%, according to Vikram Dalal, managing director of Synergee Capital Services. According to him, there was a good tax arbitrage in these funds because FDs with an interest rate of 8% could only provide individuals in the highest tax brackets with a post-tax return of 5%.

Fund companies may be able to provide an alternative by incorporating arbitrage (equity derivative methods) into some hybrid funds while still providing tax benefits.

For example, one investment expert said that the equity exposure can be kept at 40% in some hybrid schemes by adding 5% equity derivatives. However this will finally depend on the market regular Securities and Exchange Board of India (Sebi) whether it approves such a product or not. Sebi has defined each fund category and the asset allocation framework for each of these fund categories.


There is still some good news for investors who invest in a debt MF before 1 April 2023. As the new tax treatment will be applicable from 1 April.

Hence, any investment done before this date will still enjoy the LTCG tax rate of 20% with indexation benefit after three years.

If you have systematic investment plans (SIPs) in a debt mutual fund, you should be aware that units purchased after April 1 will be subject to the new tax treatment, where capital gains from the sale of these units are taxed at your income tax bracket.

Source: mint