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Is Direct debt still a smart investment choice after the new financial Bill of 2023? 

Today, we are surrounded by an unstable global financial scenario, witnessing the UBS (Union Bank of Switzerland) acquiring Credit Suisse and the collapse of the Silicon Valley Bank. An investor is jolted by knowing that big names are coming close to bankruptcy, making one rethink one’s fundamentals. The financial regulators and commentators have been asking us not to worry. Still, the scenario creates chaos in the investor’s mind and raises the question of whether to believe them. 

What is the proposed change going to take place in mutual fund taxation? 

When the global markets are in upheaval, on the domestic end, new amendments are taking place in the Finance Bill 2023. Nirmala Sitharaman, the finance minister, has announced the withdrawal of the Long-Term Capital Gain advantage that the Debt Mutual Funds were currently enjoying. Debt Mutual funds (funds holding less than 35% equity) were allowed an LTCG tax rate of 20% with an indexation benefit (if held for 36 months or more) or at 10% without Indexation.

Post 1st April 2023, any investments made in Debt Mutual funds would attract taxation as Short-Term Capital Gain according to slab rates. With the help of this proposal, it will be easier to close the loophole which high-net-worth individuals and family offices highly used. They save their money by paying comparatively less tax on their gains in Debt mutual funds.

This change will significantly affect the tax parity between Debt Mutual Funds investors and Bond/ Fixed Deposit investors. This amendment also puts the bank’s Fixed deposit at par with the Debt Mutual Funds due to their tax treatment, leading to a blow to the Asset Management Companies by losing one of their key differentiators. After all this, the industry will see a shift in the mindset of the investors. This also brings into the limelight the possibility of investing in Bonds/NCDs over Debt MFs. 

How was the taxation of Debt Mutual funds before the new Finance Bill 2023? 

Prior to the new amendment, it was permissible under the income tax laws to impose taxes on debt mutual fund schemes based on their holding period until March 31, 2023. If the redemption of the debt mutual fund scheme occurs on or before the completion of 36 months that is (3 years), then the gains on the units are called short-term capital gains. The short-term capital gains are taxed as per the tax rates applicable to the investor’s income. Although, if the investor’s holding period exceeds by 36 months, then these gains are called as long-term capital gains (LTCG), and these are taxed at 20% with an indexation benefit. 

In short, the investments made in the debt mutual funds (where the equity portion of the mutual fund scheme does not exceed 35%) on or after April 1, 2023, will be taxed as per the income tax rate slab.  

What Debt Mutual funds investors will do after this new legislation? 

Investors who want to avail the tax benefit of indexation have a limited time to invest in debt mutual funds until March 31, 2023. Any investments made in debt mutual funds by this date and at the Net Asset Value (NAV) of that day will continue to receive the indexation benefit until they are redeemed. However, any investment made in debt mutual fund units (where equity investment is up to 35%) on or after April 1, 2023, will not benefit from indexation on long-term capital gains according to the amendments to Finance Bill 2023.

It means that until March 31, 2023, the benefit from the current LTCG taxation regime will be applicable on the investments made in these debt mutual funds. The change intends to tax the gains on transfer, redemption or maturity of such debt mutual fund units in the same manner as interest income from bank Fixed Deposits (FDs) at normal slab rates. However, given judicial precedents, the new provision may lead to litigation. Removing the indexation benefit may lead to higher taxes on returns from debt funds held for more than three years and may impact the attractiveness of debt funds as an investment option. 

Which other mutual fund categories are impacted?  

Along with debt mutual funds, indexation benefits will also not be available for long-term capital gains on gold mutual funds, international equity mutual funds, and hybrid mutual funds. LTCG on gold mutual funds will be applicable if the holding period exceeds 36 months. The same applies to international equity and other mutual funds except for equity mutual funds. 

Therefore, starting April 1, 2023, gains from debt mutual funds (where equity investment does not exceed 35% of the scheme portfolio), gold, and international equity will be taxed similarly to income from bank FD. Certain mutual funds like debt mutual funds, gold ETFs, and others in which no more than 35% of the proceeds are invested in shares of domestic companies. This change in classification brings the taxation of these mutual funds in line with that of bank deposits, which will be taxed based on slab rates. 

It is important to note that the government has not made any changes in the taxation of equity shares and equity mutual funds. Long-term capital gains exceeding Rs 1 lakh in a financial year continue to be taxed at 10% without indexation benefit.  

What are the other avenues for fixed-income investment options? 

Categorically stating, we can divide the avenues for investment into 3 groups: – 

 1. Fixed Deposits: IF one chooses to invest with high-rated banks, they will be exposed to very low risk. The returns are usually lesser than those of Bonds or Debt MFs. Fixed Deposits are a popular choice for Indian Households due to the limited risk & certain returns. But they don’t have an opportunity for capital gain.

The investor can only avail of regular interest incomes. Also, FD returns seldom match inflation rates. FDs are a safer bet as the DICGC covers depositors of commercial and cooperative banks up to Rs. 5 lakhs, but we should be wary of incidents like the PMC bank scam, which can leave the depositor vulnerable.  

2. Bonds (direct debit): Bonds are becoming popular & are chosen mainly by investors seeking a higher return than FDs. Bonds are generally backed by security or Sovereign guarantees. The ratings by institutions like CARE, CRISIL, ICRA, etc., help the investor make an informed decision. Due to fluctuating yields, an investor gets to seize the price difference leading to an opportunity to earn a capital gain.

Direct Debt is the only fixed-income investment option that will have LTCG benefit if held for more than 36 months. It is taxed at 10% for listed debentures and 20% for unlisted debentures. A low-risk-appetite investor has a choice of Secured debentures, G-Sec & AAA-rated bonds that will be at par for risk exposure with FDs. However, an investor can choose lower-rated bonds to enhance his risk-reward ratio.  

3. Debt MFs: Debt funds are diversified across various securities to ensure stable returns. There will be no guaranteed return but an expected range of returns. Saying this, we cannot ignore that the risk depends on the strategy of the Fund Manager. If he chooses to play an aggressive game to achieve higher returns, the risk of the Debt MF will increase.

It’s inevitable to think about the Franklin Templeton debacle of April 2020, shaking the core of the Debt MFs industry. They had to shut down 6 debt funds due to redemption pressure and lack of liquidity in the secondary market for the underlying instruments. 

Parameters Fixed Deposits Bonds Debt MFs 
TDS 10% 10% 7.5% on dividends in excess of Rs. 5000. 
Interest Income Yes (taxed at investor’s slab rates) Yes (taxed at investor’s slab rates) No periodic interest is paid. A Debt MF may pay a dividend that is tax-free for the investor, but the fund must pay a Dividend distribution tax of ~29.12% 
Capital Gain Income No window to make a capital gain as non-tradable/transferable Yes, due to the difference in the value of the Bond Yes, due to the difference in NAV 
Capital Gain Taxability NA As per tax slabs, if the holding period lesser than 3 years. If held for more than 3 years, LTCG benefit is taxed at 10% for listed/ 20% for unlisted debentures. Yes, but the LTCG benefit will be withdrawn if invested after 1st April 2023. So, any capital gain is taxed as per slab rates and without indexation. 
Accessibility Easy Easily available to retail investors now due to various platforms Easy 
Risk Lowest Low to Moderate since Safe options are available, informed decisions can be made due to transparency on retail platforms and credit rating reports. Low to Moderate (as it depends on the strategy of the fund manager) 
Management Fee No No Almost 0.10-1% of NAV 
Inflation Can not beat inflation Beats Inflation Can beat Inflation 

Why would anyone prefer to invest in Bonds and Fixed Deposits over Debt Mutual Funds? 

For several reasons, someone may prefer to invest in bonds and fixed deposits over debt mutual funds. 

  1. Guaranteed Returns – Bonds and fixed deposits offer guaranteed returns with a fixed interest rate, which means the investor will know how much they will earn at the end of the investment period. In contrast, debt mutual funds are subject to market risks and do not offer guaranteed returns. 
  1. Less Risk – Bonds and fixed deposits are generally considered less risky than debt mutual funds as they are backed by the issuer and have a fixed interest rate. In contrast, debt mutual funds are subject to market risks, and their returns can fluctuate based on the performance of the underlying securities. 
  1. Liquidity – Bonds and fixed deposits can offer a higher degree of liquidity than debt mutual funds, as they may not have restrictions on the frequency and timing of redemptions. But in Debt mutual funds, the investor may have a restriction, which might limit the investor’s ability to access their funds. However, early withdrawal of fixed deposits may come with a penalty.  
  1. Tax Benefits – Some types of bonds and fixed deposits may offer tax benefits to investors, like tax-free interest or deductions on the amount invested. In contrast, debt mutual funds are subject to capital gains tax on the returns earned. 
  1. Lower fees – Bonds and fixed deposits tend to have lower fees than debt mutual funds, which can eat into investment returns over time. 

Overall, the decision to invest in bonds and fixed deposits or debt mutual funds depends on an individual’s investment goals and risk tolerance. Bonds and fixed deposits may be a good option for those looking for a lower-risk investment with predictable returns. At the same time, debt mutual funds may be more suitable for those willing to take on more risk for potentially higher returns. 


While concluding this Blog, we would like to tell you that it’s highly important to calculate all the factors before your investment, whether you invest in Debt mutual funds or Bonds/FDs. The factors, like investment goals, risk tolerance, and your financial situation, need to be evaluated prior. And in the above blog, we have seen several reasons that Debt mutual funds are no longer profitable for investors due to the new litigation in the Finance Bill. So, looking for other investment options for new and upcoming investors is better.