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The Finance Act 2023 has created a third category for taxation in mutual funds. We are all aware that debt funds no longer qualify for LTCG benefits. They will be taxed at marginal rate of taxation irrespective of the holding period.
In this context, the Finance Act has defined debt funds as funds having domestic equity exposure of less than 35%. Hence, it includes other categories of funds like gold funds and international FOFs.
However, the definition has opened up a new category of mutual funds from the perspective of taxation. This category is funds having exposure to equity between 35% and 65%. These funds will continue to get indexation benefits if the holding period exceeds 36 months. The category of multi asset fund (at least 10% exposure in three asset classes) may fall under this taxation ambit, depending on the positioning by the AMC. If the equity component of the fund is more than 65%, it will be taxed as equity. If the equity component is between 35% to 65%, it will be eligible for indexation. Balanced hybrid fund (50% exposure to both equity and debt) fall under this category, but currently there is no balance hybrid fund in the industry.
There are couple of multi asset funds in the market answering this description i.e. equity in the range of 35% to 65% and eligible for indexation. Certain fund houses are launching multi asset funds to benefit from this tax arbitrage.
Conclusion
The extent of indexation benefit for LTCG depends on inflation. However, history shows that post-indexation, the effective LTCG tax rate is less than 10% in most of the years, which is the taxation rate for equity funds.
Debtguru Joydeep Sen is a corporate trainer and author
