In this article, experts argue that the government should reconsider its decision and restore indexation benefits for LTCG on the sale of debt mutual funds.
Government should bring back indexation benefits on debt mutual funds
Experts say that in Budget 2024, the government should bring back indexation benefits given on LTCG of sale of debt mutual funds to make them attractive in comparison to fixed deposits (FD).
“The removal of indexation benefits for the cost of debt oriented mutual funds has made investors think on considering fixed deposits (FDs) as an alternate option for investment. In recent times, there has also been an increase in FD rates and FDs give guaranteed returns in volatile markets. In order to make investments in debt oriented mutual funds an attractive investment, the Government could consider bringing back the indexation benefit for long term capital gains from debt oriented mutual funds,” says Rama Karmakar, Tax Partner, EY India.
The second reason as to why indexation should be brought back as cited by experts is that the real returns after considering tax and inflation are negative for debt mutual funds in some scenarios.
“The Government should bring back indexation as it helps the investor to get compensated to some extent for the loss caused by inflation which is hovering between 5 and 6.5% per annum. At the present rate of return on many debt mutual funds, the investor’s real return (after factoring inflation and tax) might turn out to be negative due to higher taxation caused by denial of indexation,” says chartered accountant Prakash Hegde.CA Sandeep Agrawal, director and co-founder, Teamlease Regtech opines that as the returns on debt mutual funds are almost similar to fixed deposits, an individual will always prefer FDs over debt mutual funds as FDs are considered safer and more liquid. Agrawal suggests that all gains from debt mutual funds should be tax-exempt. “Considering that the average returns on debt mutual funds are very low and are closer to the inflation rates, in my personal opinion, the government should consider exempting the entire gains / returns on these instruments,” he says.
However not all experts agree with indexation benefits being offered to debt mutual funds. “The government need not bring back the indexation benefit on debt mutual fund, because section 50AA was inserted to maintain a level playing field for investors and earlier there was no parity in taxation system for different type of investments. This section was introduced to prevent any unintended bias while making investment choices. I do not see any compelling reason for the government to roll back this amendment in the upcoming budget,” says Deepak Chopra, chairman of direct tax committee, Karnataka State Chartered Accountants Association (KSCAA).
How removing indexation benefits pushed debt mutual funds’ real returns into negative territory
According to experts, inflation is reducing the returns from debt mutual funds. As a result, some debt mutual fund investors are not earning real income, and in some cases, they are actually losing money after considering taxes and inflation.
The below-mentioned table shows the post-tax and inflation calculation for returns earned by a debt mutual fund investor.
Source: CA Prakash Hegde. This calculation has an assumption that the investor is in the 30% tax bracket, inflation rate is 5.5% and return from the debt mutual fund is 7%.
What other suggestions do experts have for the government for Budget 2024
EY India: The government is conscious of the complexity of the capital gains structure. At present, there is no consistency in tax rates or holding periods for different types of instruments falling within the same asset class. Even the indexation benefit differs in different situations. An indication about a simplified capital gains tax regime may be expected in Budget 2024.
CA Prakash Hegde: Encouraging long-term investments, whether in debt funds or any other asset, should be an important policy of any government. Equating long-term investment with short-term investments for tax purposes acts as a disincentive to the long-term investor who helps the economy directly for long term projects/investments whether in the private sector or private sector. Ideally, benefits of exemptions under section 54EC (for investment in Capital Gains Bonds) should also be extended to LTCG from debt and equity mutual funds to encourage long-term investments. This can also help the government reduce dependency on foreign borrowings required for the aggressive infrastructure projects.