The Finance Bill Amendment & Your Debt Mutual Fund Investments: Noteworthy Changes Ahead

The proposed finance bill amendment has sparked significant interest and concern among investors, especially those focused on long-term investments. However, by closely examining the revisions, we can prepare ourselves to navigate the changes and understand the new rules to choose the best path forward.

What does the amendment in the finance bill 2023 on debt mutual funds entail?

As per the amendment, any capital gains arising from debt-oriented mutual fund schemes will be treated as short-term capital gains from April 1, regardless of the holding period. As a result, investors in such schemes will have to pay taxes as per their income tax bracket. Before the revisions came into the picture, investors in these schemes were eligible for indexation benefits on capital gains if the instruments got held for more than three years. This meant that investors who held the funds for over 3 years would only have to pay a long-term capital gains tax of 20% after indexation, significantly reducing their tax liability.

Let us say you purchased a piece of property for ₹50,00,000 in 2010 and sold it for ₹1,00,00,000 in 2023. Assuming an inflation rate of 3% per year, the indexed cost of acquisition of the property in 2023 would be ₹66,31,211, which would result in a taxable gain of ₹33,68,789 (₹1,00,00,000 - ₹66,31,211).

If indexation gets removed, the entire gain of ₹50,00,000 (₹1,00,00,000 - ₹50,00,000) would be subject to tax, without any adjustment for inflation. Assuming a capital gains tax rate of 20%, the tax liability would be ₹10,00,000 (₹50,00,000 x 20%). The tax liability, as demonstrated in the example, gets significantly increased in the absence of indexation!

Before we dive further into the subject, let us quickly define debt mutual funds.

Debt mutual funds are a secure investment choice for individuals seeking a reliable source of income. These mutual funds mainly invest in fixed-income instruments like corporate debt securities, government securities, bonds, and money market instruments. They are highly favored among investors who seek portfolio diversification and capital protection. These funds offer attractive returns with minimal risk, making them an excellent way to create passive income and accumulate wealth over the long run. Additionally, investors can adapt their portfolios and make necessary changes in response to market conditions, providing them with flexibility.

Let us explore the effect of the revisions on equity-oriented schemes!

Mutual funds that have 65% or more of their portfolio invested in equity or equity plus arbitrage, with the remaining invested in fixed income, are considered equity schemes for ITR filing and tax purposes. Categories such as equity funds, aggressive hybrid funds, equity savings funds, arbitrage funds, dynamic asset allocation funds, and some multi-asset allocation funds will be taxed as equity funds. As a result, investors will continue to pay a short-term capital gains tax of 15% if the funds are held for less than a year, and a long-term capital gains tax of 10% if sold after more than a year.

In addition to debt mutual fund schemes, several mutual fund categories will lose indexation benefits.

Let us unfold different categories of mutual fund schemes that will get affected!

1) Conservative hybrid, fund of fund investing overseas, domestic Fund of Funds, and gold/silver funds

2) Some multi-asset allocation funds that have 0% to 35% equity

Investing directly in bonds has become a compelling option for debt investors since the amendment. Taxation for bonds is now like that for mutual funds. Investing directly in bonds allows you to choose your risk level, investment tenure, and cash flow type. Options include government bonds, AAA-rated bonds, high-risk bonds, tenures ranging from 1 month to 20 years, and interest payments that are monthly, quarterly, annual, or cumulative.

The suggested alteration is likely to have a noteworthy effect on the investment sector, and investors must be ready to modify their portfolios to abide by the new tax and ITR filing regulations. It's crucial to comprehend the specifics of this change and consult taxation and investment experts.