Taxation relief: Ahead of Budget 2025, AMFI has this request from the government

The Association of Mutual Funds in India (AMFI) has called upon the government to restore the indexation benefits of debt mutual fund schemes. This appeal was made by AMFI's CEO Venkat N Chalasani during the India Fintech Forum's IFTA 2024 event on December 12. In 2023, the government made changes to the tax laws concerning debt mutual fund schemes.

Before the revision, long-term capital gains from debt funds held for over three years were subject to a 20% tax rate with indexation benefits. However, the amendments made to the Finance Bill in March 2023 eliminated these tax advantages, resulting in the income from debt mutual fund schemes being taxed based on the investor's individual tax bracket.

"We want more people to invest in mutual funds, and bringing back indexation will help in that," he said as noted in a report.

Debt mutual funds primarily allocate their assets to fixed-income securities such as bonds, treasury bills, commercial papers, debentures, and other debt instruments. These securities typically provide returns through interest payments or capital appreciation, making them a favored choice for risk-averse investors.

In terms of tax considerations, a designated mutual fund is one that invests more than 35% of its assets in the equity shares of domestic companies.

The removal of indexation benefit for debt mutual funds has led to a change in the tax treatment of long-term capital gains. As of April 1, 2023, capital gains from the sale of debt mutual funds are now taxed at the recipient's income tax slab rate, regardless of whether they are short-term or long-term gains. Investments made in debt mutual funds on or before March 31, 2023, continue to be taxed at 20% with indexation benefits for long-term capital gains (LTCG). 

In the July 2024 budget, the government made changes to the capital gains taxation regime affecting all assets. Starting from July 23, 2024, Long-Term Capital Gains (LTCG) from the sale of assets, including listed or unlisted securities, will be subject to a flat tax rate of 12.5% without the benefit of indexation. However, capital gains derived from debt mutual funds will continue to be taxed based on the recipient's income tax slab rate, rather than the new LTCG tax rate of 12.5%.

Prior to April 2023, gains from holding debt mutual funds for more than three years were classified as long-term and subject to a 20% tax rate after applying indexation. Indexation utilizes the Cost Inflation Index (CII) to adjust the asset's purchase price, minimizing the taxable gain and reducing tax obligations.

However, this indexation benefit is no longer applicable to debt mutual funds acquired on or after April 1, 2023. From this date onwards, all capital gains from debt mutual funds, regardless of the duration of holding, are treated as short-term and taxed in accordance with your income tax slab rate.

In the July 2024 budget, the government made changes to the capital gains taxation system. Starting from July 23, 2024, Long-Term Capital Gains (LTCG) from the sale of assets, including listed and unlisted securities, will be subject to a 12.5% tax rate without the option for indexation.

However, there is a different treatment for gains from debt mutual funds. Gains from debt mutual funds will continue to be taxed at the regular income tax slab rate, rather than the new LTCG rate of 12.5%. This raises concerns about how capital gains from debt mutual funds purchased before April 1, 2023, will be taxed if sold after July 23, 2024.

For debt mutual funds acquired before April 1, 2023, the LTCG tax rate has been reduced from 20% to 12.5%, but the indexation benefit has been eliminated. This change could potentially lead to an increase in your tax liability, as the previous system allowed for the adjustment of the purchase price using indexation, thus reducing the taxable gain.