Mutual Fund Investors Beware: Your Savings May be at Risk - Here's What You Need to Know

Investors should know that Budget 2023 has abolished indexation benefits for debt mutual funds, and they will now be taxed according to the investor's income tax rate.

Caution for Mutual Fund Investors

When investing in mutual funds for the current financial year 23-24, investors should be mindful of the recent government announcements on abolishing long-term capital gains tax (LTCG) and the indexation benefits provided to debt mutual funds. It is critical to consider the changes in tax regulations and evaluate one's personal aims and investment objectives to create an investment plan that aligns with their goals and risk threshold. This article explores the various elements of LTCG taxation.

Revised taxation rules for debt mutual funds

According to the revisions in Budget 2023, investments made on or after April 1, 2023, will not be eligible for indexation while determining LTCG on debt mutual funds. It will only apply to those mutual funds whose equity investments do not exceed 35%.

These debt mutual fund schemes will be taxed according to the investor's income tax rate from April 1, 2023, resulting in taxation parity between debt mutual funds and bank fixed deposits. 

These revisions do not apply to existing debt mutual fund investments.

Also ReadNew mutual fund rules introduced with effect from April 1 2023

Taxation of debt mutual funds until FY 2022-23

Until March 31, 2023, mutual debt fund schemes are subject to income tax laws based on their holding period. If the scheme's units are redeemed within 36 months (three years), the profits earned are classified as short-term capital gains and taxed at the applicable income tax rates. However, if the holding period exceeds 36 months, the profits are classified as LTCG and taxed at a rate of 20% with an indexation benefit.

Also Read: Your guide to choosing the best debt mutual fund

Impact of changes in taxation on different income groups  

The changes in taxation are likely to affect High Net Worth Individuals (HNIs) and people falling in the highest tax bracket (i.e., people who pay taxes @ 30%). Investors in the lowest tax slab or who do not pay taxes will not be affected. 

People who do not pay taxes or are in the lowest tax slab can continue to invest in debt mutual funds because of the multiple benefits, including professional management, liquidity, etc.

Other affected categories of mutual funds 

The Budget 2023's suggested modifications will also apply to international funds, gold ETFs, multi-asset funds, and conservative hybrid funds.

Current investment options available to investors 

In light of modifications in the taxation of debt mutual funds, there are multiple options for investors to consider. 

For short-term investments (up to 5 years), bank FDs and corporate bonds may be preferable over equity mutual fund shares. For long-term investments, research shows equity mutual funds provide superior returns.

The Takeaway

The recent modifications in the taxation of debt mutual funds will have a significant impact on high-income investors and HNIs. As a result, it is essential for investors to review their investment portfolios and consider alternative investment options, such as equity mutual funds, bank funds, and corporate bonds, depending on their investment horizon and risk appetite. Additionally, investors must stay informed about the latest developments and regulations in the market to make informed investment decisions.

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