In a surprising move, the govt announced several amendments to the finance bill 2023. Among the changes is the change in taxation status for debt mutual funds.
Taxation status from 1st April 2023
- Funds holding 65% or more of Indian equity or Indian equity ETFs are equity funds (no change in this)
- Funds holdings less than 65% Indian equity but more than 35% Indian equity are non-equity funds (we will refer to these as class I). Gains from units purchased on or before 3Y are short-term gains and taxed as per slab, and gains from older units are taxed at 20% with indexation (no change in this).
- The big change: Funds holding less than or equal to 35% equity will be taxed as per slab regardless of the age of the unit. Let us call these class II non-equity funds. This will only apply to fresh purchases made from 1st April 2023.
This is an awful move, as investors taking on capital market risk in the bond market will no longer be rewarded for it.
This will also affect all international equity funds and gold funds.
What should we do? Assuming the amendment is passed, we can expect AMCs to change the investment mandate to reclassify them as type I non-equity funds. This change will be easier for funds like Parag Parikh Conservative Hybrid Fund.
Fund houses can increase arbitrage exposure to more than 35% to ensure the indexation benefit is retained. Naturally, this is less than desirable but is better than paying tax as per slab, especially on long-term holdings (made after 1st April 2023).
We recommend not investing in non-equity funds until AMCs change the mandate to align with the new rules (if passed). Existing units will not be affected and can remain as is.
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