Debt mutual funds lose tax benefit in finance bill tweaks

Moving the Finance Bill 2023 in the Lok Sabha for consideration and passage, Union finance minister Nirmala Sitharaman told the House that the legislation brought in several provisions that are “helpful for the middle class and for the community as a whole”.

The Lok Sabha on Friday passed the Finance Bill 2023 with dozens of amendments to remove the tax benefits debt mutual fund investors get, give income taxpayers exceeding the lowest taxable slab of ₹7 lakh a marginal leeway that ensures their tax doesn’t exceed their income in excess of that amount, increase scrutiny of credit card payments for foreign tour packages, and set up the much-awaited appellate tribunals for disputes related to Goods and Services Tax (GST).

Opposition MPs stage a protest in Lok Sabha. (ANI)

Moving the Finance Bill 2023 in the Lok Sabha for consideration and passage, Union finance minister Nirmala Sitharaman told the House that the legislation brought in several provisions that are “helpful for the middle class and for the community as a whole”.

She said 11 new provisions have also been brought in “after stakeholder consultations” since February 1 when the Budget for the next financial year (FY24) was presented in the Parliament. The purpose of these, she added, was to “improve” the Finance Bill for better representation of the society.

Key among these is the change to how investments in debt funds are treated – the tweak will tax investments in debt mutual funds as short-term capital gains, removing the attraction of the long-term capital gains benefits enjoyed by these popular investment instruments.

Covering debt funds under short-term capital gains imply the tax will be calculated based on the investors’ income tax rate, which could go as high as 30%.

At present, the tax rules mean there is a flat 20% long-term capital gains tax on debt mutual fund units if they are sold after three years from the date of investments (any sale of units before that period attracts a short-term capital gains tax). This meant that people would normally sell these after three years and benefit from the lower tax rate.

Debt mutual funds have net assets under management of ₹12.3 lakh crore as on February 28, according to industry data.

“It seems the government wants to treat any income from debt investments as ordinary income and tax it at the highest rate. This will make debt investments like debt mutual funds and NCDs very unattractive as compared to equity,” said Rajesh Gandhi, partner at Deloitte India.

A finance ministry official, however, justified the move. “It is proposed to tax the income from debt mutual fund at applicable rate since it is of the nature of interest income. An arbitrage is being created right now where interest income from debt mutual fund (where not more than 35% invested in share in domestic company) is not distributed and converted into long term capital gains of 20% (with indexation). In some case it comes to even less than 10% due to indexation. Thus, many taxpayers are able to reduce their tax liability through this arbitrage. This is sought to be addressed,” this person said, asking not to be named.

Indexation involves pegging the calculation to the inflation rate.

The amendments also give relief to those in the lowest slab of the income tax. There is no tax liability for a person having income up to ₹7 lakh a year, but if a taxpayer’s total income crosses the ₹7 lakh threshold, they are liable to pay tax on the entire amount, which comes to ₹25,010. Now, a marginal leeway of ₹100 has been added. “Hence, marginal relief is proposed to that the tax that what one pays should not be more than the income that exceeds ₹7 lakh (i.e., tax on only ₹100 in this case),” he added.

Speaking briefly on the key amendments in the lower house, Sitharaman mentioned only three major developments amid protests by opposition members: setting up of a committee to revisit National Pension System (NPS), bringing credit card expenses on foreign tours under tax collected at source (TCS) system and setting up a GST Appellate Tribunal (GSTAT).

“One amendment [in the Finance Bill] is for the GST Council, which is establishing the tribunal,” she said. The law bringing GST into effect in July 1, 2017 has provisions to set up an appellate tribunal for disputes between assessees and the authorities – in its absence, disputes ended up in the high courts, which was time consuming and expensive.

Second, the minister added, was to bring credit card expenses on foreign tours under TCS. “It has been represented that payments for foreign tours through credit cards are not being captured under the Liberalized Remittance Scheme, the LRS, and such payments escape tax collection at source. The Reserve Bank is being requested to look into this with a view to bring credit card payments for foreign tours within the ambit of LRS and tax collection at source thereon.”

According to RBI, under LRS all resident individuals, including minors, are allowed to freely remit up to $250,000 per financial year for any permissible current or capital account transaction or a combination of both. The LRS also lays down certain activities for which tax needs to be collected at the time of a payment or remittance. Purchase of tour packages via credit cards has now been brought under its ambit, in addition to existing rules that laid down that such payments through other modes must have tax deducted.