In this article, we will be discuss the new taxation rule of mutual funds concerning the recent changes made by Finance Ministry. So, let’s get started!
new changes in the Mutual Funds Taxation rule:
W.e.f. 1st Apr 23, debt mutual funds with only around 35% equity exposure are going to be taxed differently from now on. They will be taxed at the investor’s slab rates and are now considered as STCG.
What does it mean?
It means that the investment you made in debt MFs won’t enjoy the indexation benefits (inflation adjustment) anymore. The government of india has proposed an amendment to the Finance Bill'23, which was passed in Lok Sabha on 24th Mar 23. These changes in the taxation of mutual funds are divided into 3 categories, which are as follows:
i) Equity-Based Allocation >65%:
Equity-based allocation is those funds that invest more than 65% of their fund into equity shares of domestic companies in a financial year.
Now as per the new taxation rules, there will be a STCG of 15% on equity based mutual funds if you withdraw your funds within one year of the investing.
If an individual holding equity based mutual fund for more than one year, there will be a long-term capital gain of 10% on capital gains. But in the case of LTCG, if there is a gain of Rs. one lacs, no tax will be implemented.
Taxation may vary based on the funds like Dynamic asset allocation funds, multi-asset funds, and balanced advantage funds.
Overall, there are no changes in the equity-based allocation fund as per the new taxation rule.
ii) Equity Allocation (35%-65%):
Equity allocation is the new allocation that has been introduced wherein the equity allocation in a particular fund is between 35% to 65%. It will be generally applicable to Balanced Hybrid Funds.
Here, if the individual holds the fund for less than 3 years, then it will be considered as STCG and a marginal tax rate will be applied, i.e., tax based on your slab rate.
If the individual holds the investment in this fund for more than 3 years, then it will be treated as LTCG, and flat 20% tax needs to be paid with an indexation benefit.
Indexation benefit means that individuals’ return on the fund will be adjusted with the inflation. For example: if an investor got a return of 8% during 3 years and there is CII inflation of 6%, then, he/she needs to pay tax on the gain from the fund on the adjusted return i.e. 2% (8%-6%).
Taxation may vary based on the funds like Dynamic asset allocation funds, multi-asset funds, and balanced advantage funds.
iii) Equity Allocation (0%-35%):
It will include those funds which have equity allocations of around 0% to 35%. Generally, it will include funds like debt funds, Fund of Funds, Gold ETFs, International FoF, and Conservative Hybrid Funds.
In these funds, the gain will be taxed on the marginal tax rate whether it is STCG or LTCG.
What Should Investors Do:
These changes in the taxation rules of MFs are important to understand for the investor as many times an individual plans investment from a taxation viewpoint. Hence, now since debt mutual funds or funds with allocation to equity of less than 35% have the same taxation with no benefits like indexation, etc. it becomes important for the investor to review their investment decision into these funds. Follow due diligence before making investment decisions.
Conclusion:
The new taxation rules on mutual funds will impact the taxation of mutual fund investments differently depending on the type of mutual fund and the duration of the investment. The new rules aim to bring uniformity and clarity to the taxation of mutual funds. Investors need to carefully evaluate their investment goals and tax implications before investing in mutual funds. It's recommended to consult a financial advisor to make informed investment decisions.
FAQs
Would this new rule affect only debt mutual funds?
Beyond the debt mutual funds, this change would also affect returns from gold mutual funds and international mutual funds since these mutual funds also would fall into < 35% equity exposure bucket.
Should you stop investing in new debt funds now?
While it is surprise move from Govt of India, till this new taxation rule is passed in parliament, one should not conclude anything on this.
Also, AMC / mutual fund houses need to align existing mutual funds or new mutual funds to this rule so that it is easy for investors to understand tax implications.
In some cases AMC or mutual fund houses might increase arbitrage exposure to 35% and above in a mutual fund scheme so that it would fall in equity mutual funds segment which would continue to benefit indexation benefits. Till such time, investors can hold making any fresh investments into the debt mutual funds.
Would this new rule affect existing mutual funds?
These new taxation rules are effective from 1st April, 2023. Means any fresh investment in debt mutual funds after this date, new taxation rules would apply.
mutual funds purchased before 1st April, 2023 should be ideally grandfathered i.e. The capital gains would be taxed as per old method.