AMFI's Game-Changing Proposals for Budget 2025 to Elevate Debt Fund Investments

This step could significantly enhance the attractiveness of debt funds, encouraging long-term investments and strengthening the broader financial ecosystem.

AMFI, in its proposal, stated that "It is our humble and logical request to kindly revisit the withdrawal of indexation on long-term debt investments and restore the status quo ante by amending the tax laws re-introducing the indexation benefit on long-term capital gains from debt funds in respect of all investments in debt funds made up to March 31, 2023."

In this article, we delve into the details of the AMFI proposal, its potential implications for investors and the mutual fund industry, and the broader economic context that makes these recommendations timely and critical.

Understanding Debt Mutual Funds

Debt mutual funds invest primarily in fixed-income instruments such as bonds, government securities, corporate debt, and money market instruments. These funds are preferred by investors seeking stable returns with relatively lower risk compared to equity funds.

However, the removal of the long-term capital gains (LTCG) indexation benefit for debt mutual funds in previous budgets created significant challenges. Investors are now taxed at their marginal income tax rate on capital gains from debt funds, regardless of the holding period. This change has reduced the tax efficiency of debt funds compared to other fixed-income instruments such as bank fixed deposits.

[Read: Indexation Benefits on Debt Mutual Funds Removed]

The Need for Restoring Indexation Benefits

Restoring the indexation benefit would re-establish the tax efficiency of debt mutual funds, incentivising long-term investments, and align with the government's vision of deepening India's financial markets.

Indexation adjusts the purchase price of an asset to account for inflation, thereby reducing the taxable capital gains and aligning taxation with the real value of investment growth. Restoring indexation benefits would help level the playing field, encourage long-term savings, and strengthen the role of debt mutual funds in channelising household savings into the broader financial markets.

AMFI's Broader 15-Point Proposal

Apart from restoring indexation benefits, AMFI's recommendations focus on creating a favourable regulatory and tax environment to encourage mutual fund investments. Key highlights of the proposal include:

1. Tax Parity for International Funds: AMFI seeks tax parity between domestic and international funds, encouraging investors to diversify globally.

2. Encouraging Retirement Planning: Proposals to allow greater tax exemptions for investments in equity-linked savings schemes (ELSS) and retirement-oriented mutual funds could foster long-term savings.

3. Simplifying Taxation Rules: Suggestions to streamline tax norms for mutual fund investments to reduce complexities and encourage retail participation.

4. Promoting Financial Inclusion: AMFI recommends targeted incentives for smaller cities and rural areas to broaden the investor base.

5. Reducing GST on Fund Management Fees: A reduction in the Goods and Services Tax (GST) on fund management fees could lower the cost for investors and make mutual funds more accessible.

6. Introduction of Debt Linked Savings Scheme (DLSS) to Expand the Indian Bond Market: This scheme would encourage retail investors to participate in the bond market, providing them diversified investment options and supporting market growth.

[Read: Debt Fund of Funds: Mutual Funds Finding a Way to Offer Tax-Efficient Solutions]

7. Relaxation for Mutual Funds in TDS Deduction for Inoperative PAN Cases: Mutual funds are currently required to deduct TDS at higher rates for investors with inoperative PANs, leading to administrative challenges.

Download AMFI's Union Budget Proposal for 2025-26

Why Now? The Economic Context

The recommendations come against a backdrop of evolving investor behaviour and a dynamic macroeconomic environment. Several factors underscore the importance of implementing these measures:

• Market Volatility: Persistent global uncertainties and market fluctuations have heightened the need for stable investment avenues like debt funds.

• Rising Inflation: High inflation rates make inflation-adjusted returns critical for investors, highlighting the need for indexation benefits.

• Deepening Financial Markets: With India's ambition to achieve a USD 5 trillion economy, developing robust capital markets is essential, and debt funds play a key role in this process.

[Read: Mutual Fund Taxation: Here Are the Key Changes After the Union Budget 2024-25]

Potential Impact of Restoring Indexation Benefits

If the government reinstates the long-term indexation benefit for debt mutual funds, the following positive outcomes are anticipated:

1. Enhanced Tax Efficiency for Investors

Investors would benefit from reduced tax liabilities on long-term gains, making debt mutual funds a more attractive option compared to fixed deposits and other instruments.

2. Increased Inflows into Debt Funds

Restoring indexation benefits could result in significant inflows into debt funds, aiding capital markets and providing much-needed liquidity to businesses and governments.

3. Development of Bond Markets

Greater participation in debt funds would support the development of India's bond markets, aligning with the government's financial market deepening initiatives.

4. Boost to Financial Literacy and Participation

With renewed tax advantages, more investors may explore mutual funds as a viable option, improving financial literacy and participation across the country.

[Read: Taxation of Debt Mutual Funds - Here is All You Need to Know]

Challenges and Counterarguments

While the proposal to restore indexation benefits has strong merits, certain challenges and counterarguments need consideration:

• Revenue Implications for the GovernmentReinstating indexation could lead to reduced tax revenues from debt fund investments in the short term. However, this can be offset by higher participation and long-term economic growth.

• Operational ComplexityImplementing indexation benefits may require changes to existing tax infrastructure, adding some complexity for both fund houses and investors.

• Balancing Competing PrioritiesThe government needs to strike a balance between encouraging investments and addressing fiscal constraints.

What This Means for Investors

Debt mutual funds could once again become a core component of long-term portfolios. Investors in higher tax brackets stand to gain the most, as indexation significantly reduces the effective tax rate on gains. A tax-efficient debt fund can complement equity investments, balancing risk and returns.

While the restoration of indexation benefits is a centrepiece of AMFI's proposal, the broader 15-point agenda highlights the need for continued reforms to strengthen India's mutual fund ecosystem.

This comprehensive agenda emphasises fostering digital adoption for seamless investment experiences, amplifying awareness campaigns to empower retail investors, and introducing innovative fund structures tailored to meet the diverse needs of investors.

Final thoughts...

The AMFI's 15-point proposal, including the restoration of the long-term indexation benefit for debt mutual funds, reflects a forward-looking vision for the industry. As Budget 2025-26 approaches, these recommendations have the potential to catalyse a new wave of growth in India's financial markets.

For investors, these proposals could open up new opportunities to achieve their financial goals, while for the government, they represent a chance to align tax policies with economic development objectives. Restoring indexation is not just a tax reform; it is a step toward creating a more inclusive and resilient investment ecosystem in India.

Will Budget 2025 deliver on these recommendations? Investors and industry stakeholders alike will be watching closely.

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MITALI DHOKE is a Research Analyst at PersonalFN. She is an MBA (Finance) and a post-graduate in commerce (M. Com). She focuses primarily on covering articles around mutual funds including NFOs, financial planning and fixed-income products. Mitali holds an overall experience of 4 years in the financial services industry.
She also actively contributes towards content creation for PersonalFN’s social media platforms in the endeavour to educate investors and enhance their financial knowledge.
 

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This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.