Last night a proposal to amend the finance bill 2023 was announced.  The long-term tax benefit for Debt, Gold and FOFs investing in foreign MFs, if they invest less than 35 percent of their assets in Indian equities, will be stripped off. Such mutual funds will now attract short-term capital gains tax regardless of holding period. These amendments will impact mutual fund investors for investments made on or after April 1, 2023. This would mean additional tax collections for the government next year onward.

Gains from these schemes (debt mutual funds, fund of funds, foreign funds, and gold funds) will be treated as short-term capital gains starting in April 2023 and taxed at the slab rate. An individual in the highest tax bracket will pay a tax of 30%. Currently, gains arising from debt mutual fund schemes are considered long-term after a period of three years and taxed at 20% with indexation benefits. Currently all gains are adjusted for inflation, which dramatically reduces the tax incidence. Investors have long been advised by financial advisors to consider debt mutual fund investments instead of fixed deposits because of this advantage.

This move would be a big blow to a budding mutual fund industry & a small boost to the bank term deposits. The debt MF industry currently is approximately Rs. 8 trillion compared to bank deposits’ market size of about Rs 180 trillion. The move will result in a shift of public savings away from debt mutual funds and into bank term deposits. PSU banks are the biggest deposit franchises in the country. This will mean more with PSU banks and hence more public savings under direct control of the govt and less under private fund manager control.

The removal of LTCG & indexation benefits for debt mutual funds is likely to result in lower liquidity in an already ill-liquid bond market. MFs are the only large active institutional investors who bring whatever little liquidity we have in the bond market. Insurance and some others are usually held to maturity investors.