The government’s amendment to the Finance Bill, 2023, has done away with the long-term tax benefit of indexation for debt mutual funds. This will make them on par with similar investment options.

Institutional investors accounted for 70% of investments in debt mutual funds as of December 2022. Individual investors, particularly high-networth individuals, also raised their stakes in the category, with 27% share.

Moreover, the passive fund category of target maturity funds was gaining traction.

The new rule could prompt investors to reassess their investments in debt mutual funds.

All gains from such funds with less than 35% exposure to equity would be treated as short-term capital gains and taxed as per the investor’s income tax slab level. This rule is applicable from April 1, 2023, with all investments till then grandfathered as per the previous tax regime.

The amendment divides mutual fund categories into three segments, as opposed to two previously. The new segment consists of funds that invest between 35% and 65% in equities.

On the positive side, in the newly formed segment, mutual funds could introduce more asset-allocation products, thereby expanding the range of products available to investors in the medium to long term.

Furthermore, with the tax advantage for debt mutual funds gone, product development and fund management (i.e. returns) will become the focal point determining investment flow among the available options.