The Finance Bill 2023, has inserted a new Section 50AA, providing for the taxability of any gain on transfer, redemption or maturity of the market linked debenture (MLD) on or after 01.04.2023, as a short-term capital gain, irrespective of the period of holding.
Now the scope of this newly inserted section 50AA has been further expanded to include the units of mutual fund where not more than 35% of the total proceeds are invested in equity shares of domestic companies or in other words the debt mutual funds, acquired on or after 01.04.2023.
The amendment to finance bill 2023 related to debt mutual fund has unintendedly created three categories of mutual funds for taxation.
1) Equity oriented scheme having minimum 65% equity.
2) Schemes having not more than 35% investment in equity to be taxed as short term capital gains (i.e debt oriented mu tual fund).
3) Mutual funds having more than 35% but less than 65% equity, eligible for indexation and to be taxed at 20%.Thus, w.e.f. 1.4.2023, any gain or income arising on transfer, redemption or maturity of a unit of debt mutual funds, acquired on or after 1.4.2023, will be considered as short-term capital gain, and taxable at the applicable slab rate of the investor, irrespective of the period of holding. However, investments made until March 31, 2023, will be grandfathered.
Presently, the units of debt mutual funds, held for more than three years are taxable as long- term capital gains and are taxable @ 20% plus applicable surcharge and cess, along with the indexation benefit. With effect from 01.04.2023, the indexation benefit will be removed for debt funds (acquired on or after 01.04.2023) held for more than three years, and they will no longer be eligible for a 20 percent tax rate.
Suppose Mr. A had made an investment of Rs. 10,00,000 in FY 2014-15 and had sold such investments in FY 2022-23 for a sale value of Rs. 18,00,000.
Taxation as per the present scheme
| Sale consideration |
18,00,000 |
Indexed cost of acquisition
(10,00,000*331/240) |
13,79,167 |
| Long Term Capital Gain |
4,20,833 |
| Tax Liability (20% of 4,20,833) |
84,167 |
Now considering the above illustration, Mr. A had made an investment of Rs. 10,00,000 in FY 2023-24 and had sold such investments in FY 2027-28 for a sale value of Rs. 18,00,000.
Taxation as per the amendment is as follows
| Sale consideration |
18,00,000 |
| Cost of acquisition |
10,00,000 |
| Short Term Capital Gain |
8,00,000 |
Tax Liability (30% of 8,00,000)
(Assuming applicable income tax slab rate is 30%) |
2,40,000 |
Incremental tax liability of Rs.1,55,833/-
It is interesting to note here that this amended tax treatment is also applicable on International Equity Funds, Exchange Traded Funds, Gold/Silver Exchange Traded Funds, Target Maturity Funds, Fund of Funds ETFs.
Conclusion
The intent seems to be to align all the different investment options in fixed income to a common tax structure. Though individual investors have the option to offer the interest income for taxation purposes on a receipt basis or on an accrual basis, most prefer to get taxed on an accrual basis. This is because the TDS on interest gets deducted each year and it is an administrative hassle to carry forward the TDS till the time of maturity of the fixed deposit. Also, accrual-based taxation helps avoid the possibility of inquiry from the income tax department for a mismatch of data reported to the income tax department and income offered to tax. Compared to this, gain on investments in units of debt funds are taxed only after they are sold/redeemed. Debt fund investments thus can help long-term investors postpone their tax liability to the subsequent year when the income is relatively low. However, it must be noted that the gains will still get taxed as per the slab rate.
Further it makes an interesting point in the context of the set-off of capital loss in debt funds. With indexation benefit, till now debt MF investors were able to show capital loss without any actual loss thereby saving on tax. Once the indexation benefit goes, one may not have this tax savings advantage unless your debt investments have an actual capital loss. While you can set off a capital loss in debt funds against capital gains in other assets, most investors do not make a capital loss in debt funds unless there is a credit event resulting in loss of capital.
