The government is reportedly considering reintroducing the indexation benefit for long-term capital gains (LTCG) on debt mutual funds (MFs) in the upcoming Budget for FY26. This proposal comes after the Finance Bill 2023 abolished the benefit, significantly impacting the post-tax returns for investors. Sources suggest an official announcement might be made during the Budget presentation.
Impact of Inflation on Debt Fund Returns
In recent months, the real post-tax returns from debt-oriented MF schemes have been dampened by persistently high inflation. The lack of indexation has made these funds less competitive compared to fixed deposits. Indexation adjusts the cost of a capital asset to inflation over the holding period, reducing the taxable capital gain.
Industry Seeks Parity with Listed Bonds
The Association of Mutual Funds in India (Amfi) has also called for aligning the tax rates of debt MFs with listed bonds. Currently, listed bonds attract LTCG tax at 12.5% for a holding period exceeding one year. The MF industry has proposed a similar tax treatment for debt MF units, urging the government to amend the Finance Act to classify these funds as “securities.”
Alignment of Holding Periods for Gold-Based Investments
The MF industry has additionally sought uniformity in holding periods for LTCG classification across gold-based investments, including gold exchange-traded funds (ETFs), gold mutual funds, sovereign gold bonds, and physical gold. Presently, physical gold and gold MFs require a holding period of over 24 months to qualify for LTCG, while the threshold for gold ETFs and sovereign gold bonds is 12 months.
Tax Regime Changes Since April 2023
Since April 1, 2023, capital gains from debt MFs have been taxed at the investor’s income tax slab rate, irrespective of the holding period. This replaced the earlier regime, where LTCG was taxed at 20% with indexation or 10% without indexation, while short-term capital gains (STCG) were taxed at slab rates. The new rule applied retrospectively to investments made before April 1, 2023, further increasing tax liabilities for investors.
Reversal of Indexation Withdrawal in Real Estate Sector
The withdrawal of indexation benefits in the FY25 Budget, presented in July 2024, affected all asset classes, including bonds. However, following backlash from the real estate sector, the government reinstated indexation for properties purchased before July 23, 2024. Amfi has argued for a similar rollback for debt MFs, stating that indexation is not a tax relief but a mechanism to neutralize inflation.
Investor Confidence at Stake
Amfi has emphasized that removing indexation benefits has adversely affected investor confidence in debt funds. According to Amfi, the real income from debt funds has been reduced to just 1.5% over the past 3–5 years, with average returns of 7% and inflation hovering around 5.5%. The association believes reinstating indexation benefits will encourage both existing and new investors to consider debt MFs as a viable investment option.
Expert Opinions
Anurag Mittal, head of fixed income at UTI MF, highlighted the need for policies to encourage retail participation in professionally managed debt funds, especially given the immaturity of India’s bond market. Neeraj Agarwala, partner at Nangia & Co, suggested reinstating indexation would reduce tax uncertainty and promote fairness across financial instruments.
Significant Growth in Debt Fund AUM
The latest data from Amfi reveals that the total assets under management (AUM) for debt funds reached ₹16.86 lakh crore as of November 30, 2024, compared to ₹12.57 lakh crore in the previous year. Similarly, gold ETFs increased AUM from ₹20,832.77 crore in 2022 to ₹44,244.82 crore.
Conclusion
As the government deliberates restoring indexation benefits, the MF industry remains optimistic about positive changes that could restore the competitiveness of debt funds, ensure tax parity, and enhance investor confidence. The Budget for FY26 is expected to clarify the government’s stance on this crucial matter.
