Debt Mutual Funds: LTCG Tax Benefit to be Withdrawn from Apr 1

The Finance Bill 2023 passed on March 24 has introduced new rules for tax investments in debt mutual funds as short-term capital gains (STCGs), while scrapping the long-term capital gains (LTCGs) benefits for investors. This new rule will come into effect from April 1, 2023.

As per the amendments, no benefit of indexation for the calculation of LTCGs on debt mutual funds will be provided for investments initiated on or after April 1. The debt mutual funds that will lose this particular benefit include equity investments in such mutual funds, which are not more than 35%.

Taking debt funds under STCGs means that the tax will be calculated based on the income tax rate of an investor, which could go as high as 30%. 

The move brings taxation parity between 100% debt mutual funds and bank fixed deposits (FDs). 

In addition, indexation benefit will not be available for LTCG on gold mutual funds, international equity mutual funds, fund of funds (FoFs) and hybrid mutual funds. 

Currently, the tax rules extend a flat 20% LTCGs tax on debt mutual fund units if they are sold after three years from the date of investments (any sale of units before that period attracts STCGs). This meant that an investor would generally sell these after three years and benefit from the lower tax rate.

Debt mutual funds have net assets under management (AUM) of Rs 12.3 lakh crore as on February 28, as per the Association of Mutual Funds in India (AMFI) data.

For an investor, it now makes sense to invest in debt mutual funds only with a focus on the long-term investment horizon. It is suggested that investors need to undertake appropriate steps to diversify and reassess their long-term investment plans accordingly.