The Curious Case Of Debt Funds

Consider this: Between April 2019 and March 2023, more than 22 lakh folios were added in the open-ended schemes of debt mutual funds, which is a whopping increase of 38%. This increase and rise in the popularity of debt funds was mainly on account of taxation benefits enjoyed by them over the years.

- PRIYA KAPOOR

But the recent amendments to the finance bill has taken the sheen off them and has left many investors in the lurch. As per the amended Finance Bill, capital gains on debt mutual funds (whether short-term or long-term capital gains) will now be added to one’s income and taxed according to one’s tax slab. There will not be any indexation benefit. The latter allowed one to inflate the purchase price. So when you sell your fund at a later date, you may end up paying lower tax on debt mutual funds. This benefit was only in the debt fund category.

Say you invested INR 5 lakh in a short-duration fund (debt fund) in 2019, which grew at 7% per year, it would be worth INR 6.55 lakh in four years. Under the new rules, however, a person in the 30% tax bracket will pay around INR 46,000 in taxes, while with indexation, it would have been approximately INR 12,000.

Following this announcement, mutual fund houses saw a strong rush from investors to park their money in debt funds to lock into the indexation benefits. Says Mahesh Patil, Chief Investment Officer, Aditya Birla Sun life Mutual Fund. “We saw debt funds getting strong inflows in the last week of March to benefit from the long term capital gains and indexation. Funds were received across categories both actively managed funds like corporate bond fund, long duration funds, gilt funds and also into passively managed target maturity funds.”