Centre To Propose Removing Long-Term Tax Benefits For Debt Funds: Report

India may propose that investments in debt mutual funds be taxed as short-term capital gains, according to a source with knowledge of the matter, a move that could strip investors of the long-term tax benefits that made such investments popular.

The change could benefit bank deposits, which have been growing more slowly than credit demand over the past 12 months leading to higher funding costs for lenders.

The proposed changes are likely to be part of the finance bill amendments that could be tabled in the parliament on Friday.

Mutual funds with less than 35% invested in equities are proposed to be treated as short-term and the indexation benefits that help significantly reduce tax liability available to such funds may be removed prospectively, the source said.

As such, the tax rate applicable would be based on the income tax slab in which the investor falls.

"The impact would be meaningful, if you are a debt investor, you will compare returns with other debt instruments," said Radhika Gupta, managing director at Edelweiss Asset Management Company.

Currently, investors in debt funds pay income tax on capital gains according to the income tax slab for a holding period of three years. After three years these funds pay either 20% with indexation benefits or 10% without indexation.

The proposed changes, once approved by the parliament, would be applicable to investments made on or after April 1, 2023.

The source did not want to be named as amendments to the finance bill, 2023 are yet to be presented in the parliament.

Finance Ministry did not immediately respond to an email seeking comment.

"Debt mutual funds had a favourable tax regime as compared to banks' fixed deposits and small savings," Amit Maheshwari, a tax partner at AKM Global said, adding now debt mutual funds will be taxed at par with other investments. "This could impact debt mutual funds investments in corporate bonds."

This proposed move is targeted mostly towards high net-worth individuals who were using this investment as a tax-saving instrument, Maheshwari said.

Mutual funds provided liquidity to debt investors, and the move is counter-productive to efforts for deepening bond markets in India, said Edelweiss' Gupta.

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