Finance Bill 2023 Amendment: Debt funds proposed to be taxed at par with FDs

In an unexpected move, the Finance Bill 2023 has introduced an amendment that will classify capital gains arising from debt mutual funds as only short-term capital gains. It means gains arising from debt mutual funds will be added to your taxable income and taxed at your income tax slab rate.

Currently, one of the biggest reasons for investing in debt funds is the tax advantage they offer over fixed deposits. If a debt fund is held for more than 3 years, the investor pays long-term capital gains tax at 20 per cent with indexation benefit while interest from the fixed deposit is taxed as per one's tax slab. Hence, the post-tax returns for debt mutual funds are higher than the post-tax returns of bank FDs. The short-term capital gain from debt funds, however, is currently taxed as per individual tax slab if redeemed before 3 years. 

“I hope the proposed change in the Finance Bill to remove LTCG with indexation status on debt funds is reviewed.  Financialization is just happening in India and a vibrant corporate bond market needs a strong debt MF ecosystem,” tweeted Radhika Gupta - Managing Director & Chief Executive Officer, Edelweiss Asset Management Limited

The amendment in the Financial Bill 2023 reads “Specified mutual fund means a mutual fund by whatever name called where not more than 35 per cent of its total proceeds is invested in equity shares of the domestic companies.”

Another major announcement in Budget 2023 was related to market-linked debentures (MLD), which are also proposed to be taxed as only short-term capital gain. 

Market Linked Debentures are non-convertible debentures where the return is not fixed but depends upon the performance of the underlying index. 

“While the market size of outstanding MLDs is not large in the context of debt capital markets, select NBFC issuers specially in the AA and below rating category have issued these bonds regularly in the last few years. The tax arbitrage offered by these bonds, if sold prior to final fixing/maturity is what has driven the demand for these debentures. As a corollary post the budget announcements, we expect demand to reduce meaningfully and consecutively those issuers who were issuing these MLD bonds will shift to plain vanilla debt issuances for raising resources,” said Amit Tripathi, CIO – Fixed Income Investments, Nippon India Mutual Fund told Business Today.

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