The withdrawal of indexation benefits on debt mutual funds, as outlined in the Union Budget for 2024-25, has left investors re-evaluating their strategies. The new policy, which affects funds purchased before 1 April 2023, imposes a flat 12.5% tax rate on gains without the previous indexation advantage. This change significantly increases tax liabilities compared to the prior 20% rate with indexation, making it a pivotal moment for investors who relied on indexation to reduce tax burdens, compelling a re-assessment of portfolio strategies.
To illustrate the impact, consider an investment of ₹10 lakh made in March 2023, with an expected 7% annual return. By March 2026, the investment grows to ₹12,25,043. Under the old tax regime, with a 4% indexation rate, the adjusted cost would be ₹11,24,864, resulting in a capital gain of ₹100,179 and a tax of ₹20,036 at 20%. However, under the new regime, the entire gain of ₹225,043 is taxed at 12.5%, leading to a tax liability of ₹28,130. This increase of ₹8,095 represents a 40% rise in the tax burden.
Gautam Nayak, partner at CNK Associates, explains, “In case of debt funds such as Bharat Bond Fund acquired prior to April 2023, the withdrawal of the benefit of indexation upsets all calculations of expected net return made at the time of investment – the 12.5% tax will be far higher than the 20% tax with indexed cost. The mid-term tax change will certainly create a fear of tax uncertainty amongst investors, and impact the investment climate.”
The withdrawal of the indexation benefit disrupts financial planning, especially for those relying on this advantage of indexation for better returns, Nayak added.
Sonu Iyer, tax partner at EY India, noted that debt mutual funds bought before 1 April 2023, are now treated as long-term if held for 24 months, taxed at a flat 12.5% without indexation. This shift adds a layer of uncertainty for investors, who typically depend on stable tax laws for long-term planning. It is essential for investors to consult with financial advisors to reassess their portfolios and explore tax-efficient alternatives.
The recent policy shift has not only immediate tax implications but also broader concerns about the stability and predictability of the tax regime. Investors often depend on consistent tax laws for long-term financial planning. The sudden removal of indexation benefits increases tax liabilities and adds uncertainty, potentially undermining confidence in debt mutual funds as a reliable investment.
Given these changes, investors with debt mutual funds purchased before 1 April 2023, should reassess their strategies. Consulting financial advisors to explore tax-efficient alternatives and understand the full impact is advisable. Staying informed about tax laws and their potential effects on returns is crucial.
In conclusion, the removal of indexation benefits leads to a significant tax increase and may affect investor sentiment. Understanding these changes and seeking professional advice can help investors navigate this new landscape and optimize their financial strategies.