Debt, Gold, International Funds & Fund of Funds’ gains to be taxed at slab rate

Prior to #Budget2023, there were several media reports that the Centre would tweak the capital gains regime for many securities. When Finance Bill 2023 was presented on February 1, many investors heaved a sigh of relief as it?didn’t have drastic changes?on capital gains except for making all gains on market-linked debentures as short-term capital gains at your slab rate.

But now there might be creases on the foreheads after certain amendments were made to the Finance Bill 2023 after being moved by the Finance Minister and passed by the Lok Sabha on Friday. This has changed the game for all non-equity mutual funds. Debt mutual funds, gold mutual funds, international funds, and fund of funds (including exchange traded funds) will now get similar treatment as market-linked debentures.

The only saving grace is that the new investments in such mutual fund schemes will be taxed using this new provision.?

Let us break down these changes bit by bit.

Debt funds’ taxation almost on par with fixed deposits

Banks have long complained that preferential treatment to debt mutual funds have starved them of deposits. This is because before the latest amendment was passed in parliament, gains on debt mutual fund units sold which were held for more than 36 months (3 years) were taxed at a lower rate.?

The gains (sale proceeds - cost of acquisition) on units if sold after 36 months of acquisition were earlier taxable at 20% after indexation and at 10% without indexation.?

For gains on units sold that were held for less than 3 years, the tax rate was based on every individual’s tax slab. This could go up to over 42% in the old personal income tax regime, and 39% in the amended new personal income tax regime.

The thing to note here is that the wording of the amendment in the tax law covers gold funds, international funds, and fund of funds, whether they are ETFs or normal mutual fund schemes. This means investors who like to diversify their investments into gold or invest in foreign companies through mutual funds or ETFs will also lose the benefit of indexation on long term capital gains. Gains on sale of such units will be taxed as short term capital gains at your slab rate.

What this essentially means is that income from sale of units of debt, gold, international funds, and fund of funds will have only one tax rate irrespective of how long you hold them. This change will be applicable for new investments effective April 1, 2023.

Why you should care

If you were planning to diversify your portfolio by investing in debt and gold through mutual funds or ETFs, the sweetener of concessional tax won’t be there starting April 1, 2023. Also, debt mutual funds and ETFs have been brought on par with fixed deposits.

However, there still remains a benefit in debt funds vis-a-vis fixed deposits. In fixed deposits, the interest income, whether it accrues on cumulative deposits or on deposits with regular payouts, tax is subjected to the year in which it accrues. Debt funds will continue to have the exemption on accrual of income for growth plans. So the Centre hasn’t entirely removed the beneficial treatment of debt funds but considerably reduced the gap between debt funds and fixed deposits, in terms of taxation.

If you are planning to make any investments in debt, gold and ?funds or park your savings in fixed deposits, do consult your financial advisor.

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