Mutual Funds have been a favourite investing tool among Indians for ages. We can owe this to their ease of trading, diversification, or the ease with which they lend themselves to the whole spectrum of risk-takers. One important factor to consider for everyone who invests in mutual funds is how these investments are taxed.
The central government changed the taxation of debt mutual funds while passing the Finance Bill, 2023 in Lok Sabha. Here is a look at how this mutual fund rule changes in 2023 will impact you.
Starting from April 1, 2023, the latest updates on mutual fund rules will come into effect. Investors who put their money into certain types of debt mutual funds won't get indexation benifit, for long-term capital gains, if their funds have less than 35% invested in equity stocks of Indian companies. This means that the profits they make from selling their investment after holding it for a certain period will be taxed according to their income tax slab rates. This change in tax rules aims to create fairness in the taxation of different types of mutual funds that invest mainly in debt instruments.
Until March 31, 2023, the rules for taxing a specific type of mutual fund investment that invests mainly in debt instruments are based on how long you hold it. If you sell it before completing three years, your profit is called "short-term capital gain" and is taxed according to your income tax slab rates. But if you hold it for over three years, your profit is called "long-term capital gain" and is taxed at 20%.
Basically, no matter how long you hold certain types of debt mutual funds, you will be taxed according to your income slab only. The investments made before 31st March, will not be affected by the proposed tax changes.
The mutual funds' regulatory changes will inadvertently create three categories of taxation for mutual funds.
1. Equity-oriented scheme having a minimum of 65% equity - If your holding period is less than a year, then STCG is applicable and taxed at 15%. However, if your holding period is more than 1 year, then LTCG is applicable and taxed at 10% (above capital gains of ₹1 lakh).
2. Schemes having 35% or less equity - To be taxed as short-term capital gains, which is taxed according to your salary slabs.
3. Mutual funds having more than 35% but less than 65% equity - If your holding period is less than three years, then the gain is taxed as STCG and the rate is as per your tax slab. However, if the holding period is more than three years, then taxed at 20% with an indexation benefit.
One of the biggest reasons for choosing debt mutual funds over a fixed deposit is their tax benefits. Also, debt funds held for over three years will no longer enjoy indexation benefits. Indexation means adjusting the value of the mutual fund to inflation over time. By adjusting for inflation, you can pay less tax when you sell your investment because it reduces the profit you make on it.
The change in the tax law will affect individuals in the highest income tax bracket and who invest in debt securities through mutual funds to benefit from tax advantages. Mutual fund companies may also be affected as investors may choose to invest directly in debt securities to avoid paying fees associated with mutual fund investments.
The changes will also apply to gold, international equity and even domestic equity funds of funds (FoFs).