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Tax Planning

Tax Update: What’s happening to Debt Funds?

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DSP

Mar 31, 2023 4 mins

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Summary

Stay informed about the latest tax updates affecting debt funds. Understand the changes and how they might impact your investments. This blog provides in-depth analysis and practical advice. These funds are suitable for long-term investors looking to save on taxes. They offer a unique combination of tax savings and potential for high returns over time.

You’ve probably read about the change to taxation of debt funds that Finance Minister Nirmala Sitharaman announced as part of the Finance Bill 2023. The Bill basically ends all indexation benefits on the long-term capital gains on certain debt mutual funds, effective April 1, 2023.

The heat of this move will probably be felt by retail investors, high net worth individuals, and ultra-high net worth individuals who were used to parking their money in such funds.

Let’s take a quick look at what this change is, what it means for a balanced portfolio that contains debt funds in the mix, and what a future strategy could be in light of the tax rule change.

Firstly, what is the change announced?

As per the amendments announced, any debt mutual funds whose equity investments proportion is upto 35% of the overall portfolio will no longer be eligible for the indexation benefit while calculating long-term capital gains tax. This is applicable only for investments made on or after April 1st, 2023.

Only those debt funds where the proportion of domestic equity investments is >35% but <65% (which is the threshold for equity LTCG) will continue to offer indexation benefits if held for >36 months

See this tweet below from Sunil Jhaveri, well recognized Investment Advisor, Author & Coach.

In fact, read the entire thread here, it’s the best explanation + impact breakdown we’ve seen for this event.

What is the tax on long-term capital gains (LTCG) in debt funds?

Long-term capital gains tax is applicable on any profit you would have made by redeeming debt mutual fund units held for over 36 months (3 years). Earlier, the LTCG tax on debt funds was 20% but you would get the indexation benefit. This means, you could adjust your buying price to account for rising inflation, thereby reducing your profit on paper (only for taxation purpose) and therefore exposing a lesser quantum of your returns to the 20% tax.

But you will no longer be able to enjoy the indexation benefits on debt funds with upto 35% domestic equity investments, if purchased on or after April 1, 2023.

What could this mean?

Taxation norms will become similar for debt mutual funds as bank fixed deposits. This means that you pay taxes on both debt mutual funds and bank deposit returns based on your income tax slab.

At the same time, retail investors who wish to save every rupee in taxes might look at five-year bank deposits, given that at least the interest rate they are signing up for is predetermined and, well, fixed.

But here’s the catch- if you consider a fixed deposit with a 5-year lock-in period, your money gets tied up for a considerable time. Withdrawing it for any contingency before the lock-in period ends results in a penalty. Ultimately, you might end up not just paying the tax on the gains, but also a penalty- reducing your benefit considerably.

Now look at debt funds- although abolishing indexation benefits means a direct impact on certain debt fund returns, there remains a possibility of them outperforming the interest rate offered by fixed deposits. Compared to this, debt mutual funds may be able to help you achieve a higher bottom line. But yes, you will still take on a few risks involved with any market-linked debt investment as earlier.

Few things you may want to consider, oh debt investor:

  1. Think beyond just taxation when making investments (unless your goal is to save tax, in which case: ELSS)
  2. Don’t let fear, greed, or herd mentality guide your investment decisions
  3. When the market is jittery, or when there are news-led movements, the best thing to do is actually to do nothing at all. No matter how much the noise around you.
  4. Never lose sight of your objectives - your rationale for having invested in a debt fund, your motivation to have stayed invested, and your financial goals. Zoom out and relook at the big picture.

Now if you’re a well-heeled HNI looking at debt investments, we would suggest going for a corporate bond fund such as this one. These are debt funds that invest primarily in debt instruments of companies with the highest possible credit rating (SOV/ AAA etc)- given only to companies that are financially strong and have a high probability of paying lenders on time.

Of course, before making an investment decision, please do consult a qualified professional to assess your risk profile and suitability of the products to your portfolio before making investing decisions.

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All content on this blog is the intellectual property of DSPAMC. The user of this site may download materials, data etc. displayed on the site for non-commercial or personal use only. Usage of or reference to the content of this page requires proper credit and citation, including linking back to the original post. Unauthorized copying or reproducing content without attribution may result in legal action. The user undertakes to comply and be bound by all applicable laws and statutory requirements in India.

This note is for information purposes only. In this material, DSP Asset Managers Private Limited (the AMC) has used information that is publicly available and is believed to be from reliable sources. While utmost care has been exercised, the author or the AMC does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers, before acting on any information herein should make their own investigation & seek appropriate professional advice. Any sector(s)/ stock(s)/ issuer(s) mentioned do not constitute any recommendation and the AMC may or may not have any future position in these. All opinions/ figures/ charts/ graphs are as on date of publishing (or as at mentioned date) and are subject to change without notice. Any logos used may be trademarks™ or registered® trademarks of their respective holders, our usage does not imply any affiliation with or endorsement by them.

Past performance may or may not be sustained in the future and should not be used as a basis for comparison with other investments.

Mutual fund investments are subject to market risks, read all scheme related documents carefully.

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Comments

Total 22

Arif Ahmed

23-09-2024

Mind enlightening write up. Share your universal knowledge on the subject for learning financial management of common people.

Moyukh Roy Choudhury

23-09-2024

Excellent read on discipline approach of investing and patience for long term wealth creation .

Dr.Haresh V. Mavadia

23-09-2024

Excellent

Yogesh Laddha

23-09-2024

Thanks for Sharing this Article, It's the real situation of all investors......

Jitu Pran Das

23-09-2024

Guarantee 👍

Saroj Kumar behuria

24-09-2024

Nice topic

Bhanu

24-09-2024

Beautifully penned down. Touches the right chord with the investors

Vikram Shah

24-09-2024

Great Article!

Chandra Bhushan Singh

24-09-2024

Yes patient is the key for equity investment. I remember the opportunity which I missed in 2008 Lehman Brother Crisis, The nav of DSP Tax saver was Rs 5 but now it is 80 i.e. whatever invented that time would have been converted to 16 times today. That is righ moment this blog is talking about.

Pradeep

24-09-2024

This is very interesting &amp; a very lucid way to carry the story forward without making it a text book reading. Thanks for presenting this story to us.

Saroj behuria

25-09-2024

It's very encouraging.

Deborshi Bhattacharjee

25-09-2024

Your writing is so powerful, you put into words exactly what I struggle to convey.

Karnalsingh Bajaj

25-09-2024

Very correct, very authentic, true to life. Money is not every thing. Values of life count too.

MUSADDIQUE HUSSAIN

25-09-2024

Thank you for making me aware of such an important issue. I appreciate your insights.

Partha Sarathi Chandra

25-09-2024

It’s really encouraging

RAFIQUDDIN AHMED

25-09-2024

Very informative

Reny Gomes

25-09-2024

I didn't know something like LRS even existed. Good one. Very different way of talking about a boring concept. Thanks for sharing.

Jitendra

24-09-2024

Excellent explanation. Agreed with your views and are absolutely right.

Pallav Tewari

24-09-2024

This is your first ever blog😊 , you have really displayed excellent creativity, and I am really pleased with how well you have started . Insightful &amp; excellent analogy between cricket &amp; investment. I 100%agree that investing is like playing a test match &amp; not 20-20. Patience is the key in achieving success in both . I am sure you must have already received many positive comments in your first ever blog . Keep up the excellent work !! Looking for more such interesting blogs 👍

Rizwan

25-09-2024

Ehsan that's a great read buddy, I am doing one for my son tomorrow.

Madhulika Sanghvi

25-09-2024

This is indeed so very well written - Firstly the dare to dream big but through small disciplined actions over time. Most of us imagine that one stroke of luck , that one big jump or only being a business owner or having a very senior well paying role is what creates wealth for us. Secondly the analogy to religion &amp; human behavior that is so easy to connect to with the flow of yout writing. An excellent reminder that daily doses of discipline , is important not just in wealth creation but also in work, health, relationships and life. Thanks for this piece Ehsanur!

Abhisek Mitra

25-09-2024

The parallels drawn here to illustrate the human psychology and behavior towards investing is very very apt... However the motivating factor of building a 100cr legacy for your child over a period of time with strict financial discipline is something put across the mind very thoughtfully... It's definitely a message that needs to be put across to all investors as a thought provoking one and finally help them in their pursuit of achieving this much cherished goal of "creating a 100cr legacy" by starting immediately with their SIP...

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