In a growing economy like India, with a growing base of investors, any investment vehicle built on a solid foundation will find its way to growth. All the more so, for an investment category that is well regulated, transparent and provides liquidity to an otherwise not-so-liquid underlying market. In this context, attention should be paid to the recent tax changes introduced by the government. The Finance Act 2023 mandates that investments in the growth option of debt schemes, irrespective of their holding period, be taxed as STCG, or short-term capital gains. STCG is taxed at the marginal slab rate of the investor. For most investors, apart from people in the lower income tax bracket, this is the highest slab rate. This effectively means that the benefit of indexation, which was available for investing in debt funds till March 31, has been taken away.
All fixed income investment options are now brought together on a single platform. Debt Mutual Funds (MFs) have lost much of their earlier gains. Now, the comparison between fixed income investments will be on merits. Bank fixed deposits are taxable as interest at your marginal slab rate. The bond coupon is taxable as interest at your marginal slab rate, but the capital gain component, if you sell at a higher price before maturity, is taxed as capital gain at a lower rate. The debt MF dividend option, now known as income distribution-cum-capital withdrawal option, was anyway taxable in the hands of the investor at the marginal slab rate. Now the growth option will be taxed as STCG. Market linked debentures will also be taxed as STCG from April 1.
Uniform taxation will give way to industry to grow. Here’s an analogy that proves it. On 11th September 2020, market regulator Securities and Exchange Board of India (SEBI) issued a circular on asset allocation in multi-cap funds, mandating a minimum allocation of 25% in large-cap, mid-cap and small-cap stocks . This would have meant a drastic change in the allocation of existing multi-cap funds. In less than two months, on 6 November 2020, SEBI issued a circular allowing a new fund category called flexi-cap funds. Something similar can be done in the current situation as well. Recent tax changes have created three categories in MF taxation. The former will have an equity allocation of less than 35%, which is mostly debt funds other than gold funds or international fund-of-funds. These will be taxed as STCG. The second would have equity allocation in excess of 65%, which is taxed in the case of equity. And, a third category created by amendments to the Finance Bill: Funds with equity allocation between 35% and 65%, which will be taxed as debt as before i.e. indexation benefit for holding period of more than three years with.
Hence, a category of funds can be placed in the 35-65% equity bracket. If the equity is kept on the downside, say 35-40%, it will largely retain the debt character. It would be suitable for investors looking for a holding period of 3 years and indexation benefits. Possible fund categories that might fit here are:
Balanced Hybrid Fund:A SEBI circular on fund classification issued on 6 October 2017 mentions balanced hybrid funds with an equity allocation of 40-60% of the portfolio. In the same circular, a category of aggressive hybrid funds was permitted with an equity allocation of 65-80%. However, the circular allowed only one of these, i.e. balanced or aggressive. The MF industry opted for an aggressive approach as equity taxation is preferred. In view of the recent tax changes, SEBI may consider allowing both these categories at 35-50%, with a balanced hybrid equity allocation.
Conservative Hybrid Fund: The equity allocation in this category would be 10-25%. If a slightly higher equity allocation is allowed, this category could be restored to 35% or more in equity.
Equity Savings: It has a combined allocation of equity (unhedged) and equity (hedged) of 65% or more. This can be softened so that the description is similar to that of debt funds.
Joydeep Sen is a Corporate Trainer and Author.
catch all business News, market news, today’s fresh news events and Breaking News Update on Live Mint. download mint news app To get daily market updates.