Debt mutual funds to lose long-term tax, indexation benefit; what it means for investors
Debt mutual funds that do not have at least 35% of their assets allocated to equity will no longer have long-term tax benefits. On Thursday, the Finance Ministry amended the Finance Bill 2023 to remove the tax benefit for this category, bringing these funds to the level of fixed deposits.
The Finance Ministry introduced the proposal through amendments to the Finance Bill 2023, which contains tax proposals for the financial year 2023-24. The amended bill will be sent to the Rajya Sabha for approval. The changes are valid from April 1, 2023.
What does this mean for investors?
Those who have invested in debt funds that have less than 35% of their total assets in equities will no longer have the benefit of indexation for having invested in the fund for more than 3 years. From April 1, these investors will be taxed at the income tax rate.
Prior to the amendment, debt funds, if held for more than 3 years, received long-term capital gains tax benefits and were taxed at 20% with indexation benefits or 10% without indexation benefits. Debt mutual funds held for less than 3 years were taxed at the income tax rate.
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No indexing benefits for debt mutual funds: What it means
Before April 1, 2023, investors in debt mutual funds, if held for more than three years, were eligible for the benefit of indexation. This will not apply from the new accounting year.
Indexation benefit is a tax benefit available to investors who invest in debt mutual funds in India. When an investor sells units of a debt mutual fund after holding them for more than three years, the gain on the sale is treated as long-term capital gain (LTCG). For calculation of LTCG tax, an investor can adjust the cost of acquiring mutual fund units based on the inflation index of the year in which the investment was made and the year in which the units were sold. This modification is known as indexing.
The idea behind indexing is to adjust the cost of acquiring mutual fund units to reflect inflation over the holding period. Indexation helps reduce the tax liability of debt mutual fund investors as it takes into account the impact of inflation on the value of their investment. This means that the cost of acquiring units of a mutual fund is adjusted upwards, which leads to a lower taxable profit and thus a lower tax liability.
