- On March 24, 2023, the Finance Bill 2023 introduced a big change in the taxation of certain kinds of mutual funds.
- The change is that capital gains from mutual funds with less than 35% invested in equity will be taxed at the investor’s income tax slab rate, irrespective of how long you hold. This means there is no long-term capital gains tax benefit with indexation for these funds.
- The new tax rule applies to all kinds of debt mutual funds, like liquid funds, overnight funds, short-term funds, ultra short-term funds, gilt funds, bond funds etc. The new tax rule also applies to gold ETFs & gold mutual funds, international funds of funds, and conservative hybrid funds.
- This will remove the tax advantage that debt funds enjoyed over fixed deposits. However, debt funds still have other advantages over fixed deposits – liquidity, flexibility, and transparency – which makes it better for short-term needs.
- It’s also much easier to diversify with debt funds rather than fixed deposits. Imagine opening ten different fixed deposits in different banks to diversify and manage risk!
- Action item 1: No knee-jerk actions! This change won’t affect your current investments and they will continue to enjoy indexation and long-term capital gains benefits. We recommend you make no change to your existing investments.
- Action item 2: If you have a surplus for fresh investments, you would definitely want to look at debt or gold funds before March 31st, when this change kicks in. This will allow you to benefit from indexation and long-term capital gains, provided you hold the fund for 3 years or more.