Budget 2025: Restore Long-Term Indexation Benefit For Debt Mutual Funds, Proposes AMFI

The Union Budget for FY 2025-26 will be presented on February 1, 2025. Ahead of the presentation of the Budget the Association of Mutual Funds in India (AMFI) has sent its proposals to the Ministry of Finance. The AMFI has proposed the restoration of long-term indexation benefits for debt-oriented mutual funds by amending the tax laws.

“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 benefits on long term capital gains (LTCG) from Debt Funds in respect of all investments in Debt Funds made up to 31st March 2023,” the AMFI said in its proposal.

The indexation benefit was withdrawn with the introduction of the Finance Bill 2023. According to the bill the provision was withdrawn for new investments made on and after April 01, 2023. However, investments made prior to March 31, 2023, continued to avail the indexation benefit. Before the indexation benefits were withdrawn, investments in Debt Funds held for over three years were allowed to avail an indexation benefit.

In July 2024, the indexation benefit was withdrawn retrospectively for all old long-term investments including Debt Funds. The removal of indexation was also applied to investments made before March 31, 2023. However, the benefit was restored for the real estate sector with the implementation of the Finance (No.2) Act, 2024.

The AMFI mentioned in its proposal that on a three to five year basis, Debt Funds have given returns of nearly 6-8 per cent. Given the rate of inflation which is near 5.5 per cent the gains earned by debt fund investors range only around 1.5 per cent. The regulatory body also highlighted that indexation is not a tax waiver but a neutraliser to the impact of inflation.

“Debt Mutual Funds on a long-term average basis give returns in the range of 6 to 8 per cent. Indexation is not a tax waiver but a neutralizer to the impact of inflation. The removal of indexation benefits will have a material impact on Debt Mutual Fund investors. It may be noted that the debt mutual fund investors have anyway been getting taxed at a marginal rate since April 01, 2023, which has already hurt them significantly. Now, removal of indexation benefits for grandfathered investment before March 31, 2023 will hurt old investors also,” the AMFI said.

AMFI added that the application of new tax rates on a retrospective basis can deter new investors from investing in mutual funds.

“We believe that applying the new tax rates on a retrospective basis can be detrimental to investor confidence and deter new investors from entering capital markets as well as the existing ones to make further investments in the capital markets through mutual funds as these investors had invested in the funds based on the tax rates prevalent at the time of their investments.”

Vivek Sharma, the Investment Head at Estee Advisors, a quant-based investment management and execution and services provider told Outlook Money that the restoration of long-term indexation benefits would make debt oriented mutual funds more tax-efficient.

 “The restoration of long-term indexation benefits for debt mutual funds would be a big win for investors. It would make these funds more tax-efficient by allowing inflation to reduce taxable capital gains, leading to better post-tax returns. And it also makes debt mutual funds more competitive compared to fixed deposits, especially for those in higher tax brackets,” Sharma said.

 Sharma added that the restoration of the long-term indexation benefits for debt mutual funds is also necessary to create a level playing field for investors. 

“The restoration of long-term indexation benefits for debt mutual funds is necessary to create a level playing field for investors and foster a balanced investment ecosystem. This move would allow investors to adjust their purchase price for inflation, reducing taxable capital gains and making debt mutual funds more tax-efficient compared to fixed-income instruments like fixed deposits,” Sharma told Outlook Money.