It's advantage FD with debt mutual funds set to lose popularity

Mumbai: Debt mutual funds are set to lose their tax advantage as a preferred investment option within the fixed-income basket among investors falling in the highest tax bracket. Capital gains arising from investments made in debt mutual fund schemes will be added to taxable income and taxed in line with the income tax slab rate, as per an amendment in the Finance Bill 2023 coming into effect on April 1.

This means the indexation benefit in debt mutual funds that lowered the tax outgo for investments held for more than three years has been removed. With this, they will be taxed like other fixed income instruments such as fixed deposits, non-convertible debentures (NCDs) and bonds.

Wealth managers said investors will now increasingly consider fixed deposits and other debt instruments that have been offering better rates than several debt mutual funds.


"Fixed deposits will be at par with some debt schemes once the tax advantage is gone from a retail investor's perspective," said Ashish Shankar, MD and CEO, Motilal Oswal Private Wealth. "For HNIs and family offices, direct debt and structured debt will become more attractive."

Liquid schemes, in which investors and companies park their idle cash, will be least impacted as the investment horizon in this debt category is lower anyway.

According to the Finance Bill amendment, investments in mutual funds with equity allocation of up to 35% will be taxed in line with an investor's income tax slab rate. Income from debt funds, gold funds and international funds will now be deemed as short-term capital gains and taxed at the marginal rate.

Currently, a debt fund held for more than three years is liable for 20% capital gains tax with indexation benefits.