India will tax investments in bond mutual funds as short-term capital gains, under amendments to the Finance Bill passed by parliament on Friday
The tax benefits of the term investors have made these investments so popular.
The shift could boost bank deposit growth, which has struggled to keep up with credit demand over the past 12 months, increasing funding costs for lenders.
It is proposed that mutual funds with less than 35% invested in domestic equities are considered short-term and that the indexing benefit that significantly reduces taxes payable on such funds may be eliminated in the future.
As such, the applicable tax rate will be based on the income tax bracket the investor falls into.
The Treasury Department did not immediately respond to an email seeking comment.
“The impact would be meaningful, if you are a debt investor, you will compare returns with other debt instruments,” said Radhika Gupta, managing director at Edelweiss Asset Management Company.
The mutual fund industry is likely to request the finance ministry to take a relook at the decision, said two mutual fund executives on condition of anonymity.
As of Dec. 31, 2022, assets under management for debt-oriented products stood at 12.42 trillion rupees ($151.04 billion), according to industry data.
Currently, investors in debt funds pay income tax on capital gains according to the income tax slab for a holding period of three years. After three years these funds pay either 20% with indexation benefits or 10% without indexation.
The new tax rules would apply to investments made on or after April 1, 2023, impacting new inflows into these funds.
Amit Maheshwari, a tax partner at AKM Global, said mutual funds have a more favourable tax regime than fixed deposits and small bank savings
“This could affect debt mutual fund investments in corporate bonds.
The move is primarily aimed at high net-worth individuals who are using the investment as a tax saver, Maheshwari said.
Edelweiss’ Gupta said mutual funds have provided liquidity to bond investors and the move backfires with efforts to deepen the bond market in India.
Indian banks, which hold 178 trillion rupees in deposits, could be the beneficiaries if the revised proposal is passed.
Suresh Khatanhar, deputy managing director of IDBI Bank, said that money from wealthy individuals and institutions is invested in these funds, which can be transferred to bank deposits.
Mutual funds used this money to finance the working capital needs of the business. Khatanhar added: “If they get less money as a result of the arbitration process ending.
It will also benefit the banks because this business opportunity will come to the banks to refinance.
Bank deposits increased 10.1% year-on-year in the two weeks to February 24, while credit demand increased 15.5%.