Modi 3.0 May Tweak Capital Gains Tax on Debt Mutual Funds

Besides, a 72-member Council of Ministers took oath -- nine short of the maximum permissible strength. So, in effect now we are officially in Modi 3.0, and many are hopeful that the government will continue to walk on the path of structural reforms path, which can help realise the dream of 'Viksit Bharat' or advanced India by 2047.

Amongst many reforms, tax and capital market reforms are also important ones for wealth creation. During the Modi regime, the Indian equity market, i.e. the S&P BSE Sensex -TRI, has clocked a 13.7% CAGR (as of June 7, 2024). This is despite the fact that the Long Term Capital Gain (LTCG) tax on shares and equity-oriented mutual funds was introduced by the Modi regime in the Union Budget 2018.

Last year, concerning debt investments, the Modi-led-NDA government removed indexation benefits on debt mutual funds with effect from April 1, 2023. This made capital gains from non-equity oriented funds (including gold funds) and debt mutual funds, irrespective of Short Term Capital Gain (holding period less than 36 months) or Long Term Capital Gain (holding period of 36 months or more), taxable as per the investors'/assessees' income-tax slab rate, i.e. at the marginal rate of taxation.

In other words, the 20% indexation benefit that earlier helped to make the most of the inflation impact on the purchase value of the investment and effectively reduced the LTCG tax liability was no longer made available for debt mutual funds from April 1, 2023. Simply put, debt mutual funds were made at par with bank Fixed Deposits (FDs) as regards taxation.

Watch this video to learn more about taxation of mutual funds:

However, now having its ears to grounds and learning that change in the aforesaid tax rule is proving to be a dampener for investments in debt mutual funds, the government is now planning to tweak the capital tax rule for debt mutual funds.

According to a government official who spoke to the Economic Times, the issue figured at a meeting last week in the finance ministry as the government is planning to roll out a fresh tranche of Bharat Bond Exchange Traded Funds.

"DIPAM (Department of Investment and Public Asset Management) will send a formal recommendation in this regard to the Department of Revenue for consideration after the government formation," said the government official.

Currently, finance ministry officials are meeting with PSUs to consider their fund requirements in the current fiscal year (as the Bharat Bond ETFs are issued by Central Public Sector Enterprises and Central Public Sector Financial Institutions, and other government undertakings). Since its launch in December 2019, Bharat Bond ETFs cumulatively have raised over Rs 30,000 crore in the four issues/offerings so far.

[Read: All You Need to Know About Bharat Bond ETFs]

Given this development, it is possible that in the upcoming full budget of Modi 3.0 (which will be presented in July 2024), debt investors may hear of the tax relief -- wherein the erstwhile indexation benefit for LTCG tax may be restored.

That being said, it is still unclear whether this relief would apply to only Bharat Bond ETF or even be extended to debt mutual funds while the Association of Mutual Funds in India (AMFI) is taking up the 'Mutual Fund Mein Fixed-Income Wali Baat' campaign (aim at replicating the success of 'Mutual Funds Sahi Hai' campaign).

If this tweak in the capital gains tax rule truly applies even to debt mutual funds, it would give a boost to debt mutual funds, encouraging both institutional and individual investors.

How to Approach Debt Mutual Funds Now

Keep in mind that investing in debt mutual funds, in general, is not risk-free. They are subject to interest rate risk, credit risk, and liquidity risk. The degree of risk varies depending on which sub-category(s) of debt funds you choose to invest in. As a prudent investor, you should choose the safety of the principal over returns. Avoid investing in debt funds that engage in yield hunting to clock higher returns.

At present, given that interest rates are near the peak, it would be an opportune time to invest in longer-duration debt mutual funds with a medium-term view of 3 to 5 years, whereby you benefit from higher yield and unlock the capital growth. However, it is best to invest in these funds in a staggered manner. If you have a shorter investment horizon, consider investing in the shorter maturity debt funds, as they have a minimal mark-to-market impact when interest rates rise.

For an investment horizon of up to or less than a year, it would be better to stick to the best Liquid Funds and/or Overnight Funds that have no exposure to private issuers.

When investing always assess your risk appetite and investment time horizon while investing in debt funds.

Also, when you invest in debt mutual funds or any investment avenue for that matter, it is important to know the tax implications. Hard-earned money legitimately saved from tax is ultimately earned and is in the interest of your financial well-being.

Approach investments thoughtfully.

Happy Investing!

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Disclaimer: This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes. Use of this information is at the user's own risk. The user must make his own investment decisions based on his specific investment objective and financial position and use such independent advisors as he believes necessary.