Indexation benefits are no longer available on long-term capital gains (LTCG) on debt mutual funds. From April 1, 2023, debt mutual funds (MFs) are getting taxed as per the income tax slabs of an individual’s income. The changes were introduced by the government in the Finance Bill 2023 which was passed last week during the Budget Session.
With the indexation benefits gone, returns on debt mutual funds are now taxed as per the individual’s tax slab, which is the same for fixed deposits. Before this, investments in debt MFs held for three or more years used to be taxed at the LTCG rate of 20 per cent, or without indexation, at 10 per cent.
Experts say that with indexation benefits gone, investments in debt funds would come at par with banking and other fixed-income products. Or, as many investors think, debt mutual funds will be just like fixed deposits. But is it true?
Mayank Bhatnagar, Chief Operating Officer, FinEdge said, “Many investors make the mistake of investing into debt funds believing they are “just like FDs”. As a result, they end up surprised when debt fund NAVs fluctuate due to interest rate movements or credit events within their portfolios.”
Fixed deposits, he said, “provide linear and predictable returns in the form of interest payments, and so they are structurally different from debt funds.”
According to Lallit Tripathi, chairman and managing director of Vedant Asset, “FDs have become an equivalent asset class compared to debt funds post 1 April 2023. After the indexation benefits moving out, the returns would be the only criteria to invest in any asset class.”
Debt MFs “have an edge over FD in terms of returns generated in a longer period of horizon,” he added.
Taxation
Investments in FDs are taxed every financial year while investments in debt mutual funds are only taxed at the time of withdrawal. Thus, an individual investing money in FDs will pay taxes on the returns every financial year. While if an individual holds her money in debt mutual funds for 10 years, she would not pay any taxes for that duration. The investor will only be taxed when she decides to withdraw her money from the fund.
Withdrawal flexibility
Compared to fixed deposits, debt funds offer more flexibility to individuals, as investors can withdraw from their investments in mutual funds anytime, and for any amount they want.
Debt funds are more liquid than FDs, Bhatnagar explained, saying, “…one can partially access their capital without impacting the returns on the entire investment. The premature termination of an FD will, however, invite a penalty on the entire deposit, as one cannot liquidate it partially.”
However, he warned, investors should keep in mind that “fixed deposits themselves are not completely devoid of risk.” He said, “One should not go rushing into a high-yielding FD from a small savings bank without a thorough evaluation of the risks involved.”
Returns
Indexation benefit was one of the key reasons for investments in debt mutual funds, Tripathi said, adding, “Actively managed debt funds have been able to deliver much better returns compared to FD.”
On average, fixed deposits generally offer a return of 7 per cent, as compared to debt MFs, the returns of which vary on different funds. Unlike FDs, the interest on mutual funds is not pre-decided and is volatile.
Tripathi said, “People who do not want to ride the interest rate volatility and are happy with a consistent return will opt for bank fixed deposit over debt mutual funds.”
According to Bank Bazaar, RBL Bank is currently offering the highest return rate on FDs at 7.80 per cent for investments below Rs 2 crore. The rates of FD are currently above average, due to a higher repo rate, the key interest rate at which RBI lends money to banks.
“Going forward, when we will see the interest rate cycle stable after [a] few quarters, I am sure that debt mutual funds would still be a better investment option compared to bank fixed deposits in returns at least.”
He said, “In the long run, fund managers will have the challenge to beat the returns of bank fixed deposit to make the investors invested in this asset class.”
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