Capital gains tax: AMFI urges to restore indexation benefits for debt mutual funds after real estate breather

Capital Gains Tax: After Finance Minister Nirmala Sitharaman made an announcement in the Union Budget regarding the reduction of tax on long-term capital gains from 20% with indexation benefits to 12.5% ​​without indexation benefits, an amendment was introduced to The Finance Bill, 2024. This amendment allows taxpayers to select the tax rate that is more advantageous for them when dealing with the transfer of immovable assets such as land and buildings acquired before July 23 of the current year.

This also includes the recent introduction of a grandfathering provision for property transactions before July 23. The Finance Bill (No. 2) of 2024 was introduced by FM Sitharaman on July 23, 2024. After undergoing amendments, the Bill was passed by the Lok Sabha on August 6, 2024.

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Following the real estate sector breather, the Association of Mutual Funds in India (AMFI) has requested the Center to restore the indexation benefit for debt mutual funds. Additionally, the AMFI is advocating for an extension of the grandfathering provision pertaining to these benefits. The proposed timeline for the extension of the grandfathering provision is until July 2024.

Various financial sectors, including the mutual fund industry body, expressed concerns regarding the retrospective removal of indexation benefits from all asset classes in the Union Budget. After the government decided to partially reverse the removal of indexation benefits on property transactions, AMFI has reiterated its request for a similar extension to debt mutual funds for protection.

Capital Gains tax for debt funds

AMFI outlined some serious concerns and possible consequences arising from the retroactive enforcement of modifications to capital gains taxation. An area of ​​primary focus pertains to investments allocated to funds with over 65% exposure to debt securities or money market instruments as of March 31, 2023. Investments in schemes with less than 65% allocation to debt instruments made after March 31, 2023, will face the regulations passed in Union Budget 2023. similarly, redemptions from schemes with more than 65% equity investment made after July 22, 2024, will also be impacted by the updated guidelines.

Indexation is a crucial method employed to account for inflation’s impact on a capital asset’s cost over time. By adjusting the asset’s cost, indexation aims to reflect the effects of inflation since the asset was originally procured. This adjustment results in a higher inflation-adjusted cost of acquisition for the capital assets, subsequently leading to reduced net long-term capital gains (LTCG).

However, it is worth noting that Budget 2023 has abolished indexation benefits for debt mutual funds that are acquired on or after April 1, 2023. As a consequence of this change in policy, investors in debt mutual funds will no longer be able to avail themselves of indexation benefits starting from the above-mentioned date.

The AMFI has requested a review of the decision to eliminate indexation benefits for debt mutual funds. Alternatively, it has suggested that the government consider implementing indexation for the holding cost of these funds until July 23, 2024.

It has also put forth a suggestion that a grandfathering clause should be implemented for investments in pertinent fund categories. This proposal mirrors the regulations established for equity investments in 2018. This means, the AMFI is advocating for the grandfathering provision to cover debt investments made prior to the year 2023, and for schemes with a debt allocation exceeding 65% to be included until 2024.

The AMFI has explained that the proposal underscores the significant impact on debt mutual fund investors, particularly those relying on long-term returns averaging 6% to 8%. The elimination of indexation benefits, coupled with taxation at the marginal rate since April 1, 2023, has already caused considerable financial strain on these investors.

It argues that the removal of indexation benefits for grandfathered investments made before March 31, 2023, would further disadvantage older investors who rely on these returns for their financial security.

Before the Union Budget 2024, experts too said that the government should consider reinstating indexation benefits on Long-Term Capital Gains (LTCG) from the sale of debt mutual funds. This measure can potentially enhance the attractiveness of debt mutual funds compared to fixed deposits (FD).

“The Government should bring back indexation as it helps the investor to get compensated to some extent for the loss caused by inflation which is hovering between 5 and 6.5% per annum. At the present rate of return on many debt mutual funds, the investor’s real return (after factoring inflation and tax) might turn out to be negative due to higher taxation caused by denial of indexation,” says CA Prakash Hegde.

“The removal of indexation benefits for the cost of debt oriented mutual funds has made investors think on considering fixed deposits (FDs) as an alternate option for investment. In order to make investments in debt oriented mutual funds more attractive, the Government could consider bringing back the indexation benefit for long term capital gains from debt oriented mutual funds,” says Rama Karmakar, Tax Partner, EY India.