Capital Markets: Challenges and Developments

Scrapping Tax Benefit for Debt Mutual Funds: Analysis


From UPSC perspective, the following things are important :

Prelims level: Facts related to mutual funds

Mains level: Mutual funds, debt mutual funds, tax benefits, etc

Central Idea

  • The Finance Bill 2023, passed by the Lok Sabha with 64 amendments, includes the controversial decision to remove the tax benefit for debt mutual funds. While the aim is to remove the advantage of debt funds over bank deposits, this decision will have far-reaching consequences that need to be examined.

Mutual Funds

  • Investment decisions on behalf of the investors: Mutual funds are investment vehicles that pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities. Mutual funds are managed by professional fund managers who make investment decisions on behalf of the investors in the fund.
  • Diversified portfolio of securities: Investors in a mutual fund own a proportional share of the fund’s underlying assets, and the value of their investment rises or falls in response to changes in the value of the securities held by the fund. Mutual funds can provide investors with access to a diversified portfolio of securities, which can help to mitigate the risk of investing in individual securities.

Key differences between Mutual funds and debt mutual funds

  • Mutual funds and debt mutual funds are both types of investment funds, but there are some key differences between them
Comparison Mutual Funds Debt Mutual Funds
Types of Investments Stocks, bonds, commodities, and other asset classes Fixed-income securities such as bonds, debentures, treasury bills, and commercial papers
Risk Generally higher risk due to the inclusion of stocks and other volatile assets Generally lower risk due to the focus on fixed-income securities
Returns Potentially higher returns over the long term, but subject to more volatility Lower returns compared to equity mutual funds, but also come with lower risk
Investment Objective Can vary widely depending on the type of fund Provide regular income to investors while preserving capital
Liquidity Can be less liquid than debt mutual funds due to volatility in underlying securities Generally considered more liquid due to less volatility in underlying securities

The Debate Over Scrapping Tax Benefit for Debt Mutual Funds

  • Removal of the tax benefit for debt mutual funds: The Finance Bill 2023 passed by voice vote in the Lok Sabha last week with 64 amendments, including the removal of the tax benefit for debt mutual funds.
  • What it means: This change means that investors in debt mutual funds cannot avail the benefit of indexation for the calculation of long-term capital gains. From April 1, such investments will now be taxed at income tax rates applicable to an individual’s tax slab.
  • Motive: This move aims to remove the advantage that such debt funds have over bank deposits. However, the consequences of this decision need to be carefully examined.

The Impact of Removing Tax Benefit

  • Impact on flow of funds: The removal of the tax benefit will lead to investors reassessing their allocations to debt mutual funds, which may impact flows into these funds.
  • Impact on bond market: This, in turn, may impact the growth and development of the bond market in India since debt mutual funds channel funds into the bond market.
  • For instance: According to a report by Crisil, 70% of the investment in debt funds flows from institutional investors, while individual investors, including high net worth individuals, accounted for 27% as of December 2022.
  • Impact on corporate debt: This change in rule may trigger a shift in investments away from debt mutual funds to other instruments, which will possibly affect flows to the corporate bond market, and demand for corporate debt is likely to be impacted.

The Need for Rationalization

  • There is a need to acknowledge the finer points of differentiation between bank deposits and debt funds since bank deposits are insured up to Rs 5 lakh while debt mutual funds carry risk depending on the risk profile of the bonds they hold.
  • It has been argued that the capital gains architecture in India needs to be reexamined and reconfigured.
  • Not only are there different rates of taxation for different asset classes, but even the holding period for differentiating between short- and long-term capital gains varies across assets. Thus, rationalisation with regard to the tax rate and/or the holding period is desirable.


  • While the removal of the tax benefit for debt mutual funds may remove the advantage of such funds over bank deposits, its far-reaching consequences need to be carefully examined. There is a need to acknowledge the finer points of differentiation between bank deposits and debt funds, as well as rationalisation of the tax architecture in India. Therefore, there is a need for broader discussions and debates on these issues.

Are you an IAS Worthy Aspirant? Get a reality check with the All India Smash UPSC Scholarship Test

Get upto 100% Scholarship | 900 Registration till now | Only 100 Slots Left


Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

Notify of
Inline Feedbacks
View all comments


Join us across Social Media platforms.

💥Mentorship New Batch Launch
💥Mentorship New Batch Launch