On March 24, 2023, Finance Minister Nirmala Sitharaman made an announcement that caused disappointment among India‘s largest mutual fund houses. The Finance Ministry amended the Finance Bill 2023, eliminating the long-term tax benefit that debt fund investors enjoyed after three years of investment. This move brings debt funds in line with bank fixed deposits (FDs) and removes the tax advantage that debt mutual funds had.
The changes under the Finance Bill will come into effect from next month, at the beginning of the next financial year, FY24. As a result, bank FDs will become more attractive, as both debt funds and bank FDs will be subject to the same taxability of maturity proceeds. This move may hurt all debt funds, especially in the retail category, as ultra-high net worth and high net worth individuals may choose to invest in safe havens like bank fixed deposits.
Experts predict that this move might result in a shift from long-term debt funds to equity funds, sovereign gold bonds, bank fixed deposits, and non-convertible debentures in the debt category. This move affects not just debt funds but also other non-equity debt schemes like gold, international equities, and funds of funds (FoF).
The move is good news for banks, as they can attract customers with higher interest rates and increase their borrowing and saving book sizes. The Finance Minister’s decision to remove the tax arbitrage that debt mutual funds provided, allowing investors to pay a lower rate of tax if they hold onto the investment for over three years, has left asset managers surprised. The mutual fund industry has been playing a key role in the development of both the equity and bond markets, and the move came as a surprise to them.
In conclusion, the Finance Minister’s move to remove the tax advantage that debt mutual funds had will likely result in more interest in bank fixed deposits, hurting the debt funds, especially in the retail category. This move may also result in a shift from long-term debt funds to equity funds, sovereign gold bonds, bank fixed deposits, and non-convertible debentures in the debt category. Banks are likely to benefit from this move as they can attract customers with higher interest rates and increase their borrowing and saving book sizes.