Government May Reintroduce Tax Benefits for Debt Mutual Funds in AY26 Budget
In order to relieve the complaints regarding low post-tax returns, the government has taken a stand on reinstating the tax reliefs on Debt MFs. The long-term capital gains indexation benefits, which were previously available against debt funds, were removed in the Finance Bill 2023. However, there is an expected announcement in the AY26 Budget.
The indexation benefit, which adjusts the time depreciation of an investment to reflect inflation, was available for LTCG on debt funds. Since, April 01, 2023 `debt mf`, has been changed to a taxation, wherein the investor pays tax according to their income slab irrespective to the length of time the investment was held. This has shifted tax pressure on many investors and has made debt funds instead of fixed deposits a less lucrative option.
The lack of indexation in the first place meant that the debt fund investors have had almost zero or negative real returns due to the effects of inflation and the retroactive effect taxation has. In the past 3-5 years, 7% was the average return from debt funds, while inflation cutoff was 5.5%, leaving a meagre 1.5% as returns after tax.
The mutual fund industry has made two main requests to the government:
1. Bring Back Indexation: They want the government to bring back the indexation benefit for debt fund investments made before March 31, 2023. Indexation helps adjust the investment cost for inflation, reducing the tax on profits.
2. Same Tax as Listed Bonds: They have asked for the tax on long-term profits from debt funds to be the same as listed bonds, which is 12.5% if held for more than one year.
A requirement is also felt on the uniform holding period for calculation of LTCG on investments in gold. As of today, the same 24-month holding period would be eligible for LTCG only for gold mutual funds and physical gold. Gold ETF and sovereign gold bonds qualify for the same after 12 months holding period.
In July 2024, the government took away indexation benefits for all asset classes, including bonds. In August 2024, after complaints from the real estate sector, the government brought back the indexation benefit for long-term capital gains (LTCG) on properties bought before July 23, 2024. Since then, the mutual fund industry has asked for the same benefit for debt funds. They believe indexation is not a tax discount but a way to adjust for inflation’s effect on investments.
According to sources, the finance ministry is considering debt mutual funds as “securities” instead of “special mutual funds” in the Finance Act. This would help ensure long-term investments in the debt funds have the same status as the listed bonds, with the government imposing a tax rate of 12.5 percent.
Significance of Debt Funds
Debt funds serve to channel retail investment into professionally managed portfolios. While the Indian bond market is growing, removing the indexation advantage has led to uncertainty in investing. The importance of reviving the indexation advantage has come to be associated with the requirement of regaining investor confidence as well as of participation in the capital markets.
Asset Management Information
On November 30, 2024, the total AUM of debt funds reached Rs 16.86 lakh crore, compared to Rs 12.57 lakh recorded a year ago. Investing in gold ETFs which is still one of the most popular investment vehicles, had an AUM of Rs 44,244.82 crore on November 30 2024, while an amount of Rs 20,832.77 crore was reported in November 2022.
Moreover, the mutual fund industry continues to hope that favorable measures will be taken by the government in its forthcoming Budget for AY26. Legalizing the indexation and bringing the tax rate of the funds in line with that of listed bonds might make more enticing the debt mutual funds, enhance the after-tax returns and stimulate the long-term savings. Such measures would benefit investors but would also help bolster the development of the financial markets in India.
