In recent years, the domestic mutual fund industry has attracted investors across various segments. Ahead of the tax and policy proposals in the Budget, industry players, consultants, and associations are preparing their recommendations. These include addressing anomalies in the interpretation of tax laws, advocating for tax treatment parity, and other measures to support sectoral growth and help India maintain its momentum as one of the fastest-growing emerging economies.
The mutual fund industry is no exception to this trend. It has been at the forefront of contributing to the growth of capital markets. Assets Under Management (AUM) and Systematic Investment Plan (SIP) inflows reaching all-time highs at INR 68 lakh crores and INR 26,000 crores, the mutual fund sector has successfully penetrated the Indian market, channelling household sector funds back into the capital markets.
The year 2023 saw a couple of new entrants in this most lucrative financial service. Another 6 applicants are about to step into this INR 68 trillion industry in 2025, as the capital markets regulator has granted them in principle approvals in the past couple of months which includes large established corporate houses venturing in this evolving sector.
In Budget 2024, one of the key proposals was the reintroduction of indexation benefits, which had been withdrawn the previous year. The industry is now hopeful for similar tax reforms in Budget 2025, particularly the return of tax relief for debt funds and the potential reintroduction of indexation benefits.
Economically, indexation benefits are designed to neutralise the impact of inflation when calculating the cost of investments. The withdrawal of such benefits would result in higher taxable gains, resulting in increased tax liability. This could act as a significant deterrent for investors looking to deploy funds in the debt markets.
Also read: Personal Taxation in Budget 2025: Our top 10 predictions
Another widely anticipated request is the introduction of tax incentives to the Debt-Linked Savings Scheme (DLSS), similar to those available for Equity Linked Savings Scheme (ELSS). Such incentives would encourage long-term savings by retail investors in high-quality debt instruments while also helping to deepen the bond market. Investments in DLSS should be eligible for deductions under Section 80C of the Income Tax Act, 1961, in the same way that ELSS investments currently are. This would create a level playing field for debt-oriented mutual funds, bringing them on par with tax-saving bank fixed deposits, which also benefit from deductions under Section 80C.
The debt market plays a pivotal role in shaping the economy by providing essential liquidity, offering attractive long-term returns to investors, supporting capital expenditure (capex) for corporates. The wish is to align the tax treatment of debt mutual funds with that of listed bonds, allowing capital gains on units held for more than 12 months to be taxed at the 12.5% long-term capital gains rate.
This will encourage retail investor participation in the debt market, which remains not fully saturated by the spectrum of domestic investments in India.
In order to reduce the operation costs and make the capital markets lucrative to retail investors, representations are being made to either abolish or at least make a reduction on the STT rates on F&O transactions. Harmonising of capital gains tax rates and of STT on trades will demonstrate the government’s seriousness in keeping the capital markets open for retail investors, giving better returns with minimal cost of investment.
Further, the much talked about issue in the mutual fund sector is the highlight of the previous Budget announcements on introduction of Specified Mutal Fund (SMF). A suitable clarification from the CBDT to amend the definition under section 50AA of the Income-tax Act, 1961 with respect to SMF. Mutual fund schemes (including FOFs) investing over 35% of their AUM in domestic equity shares should not fall under the short-term capital gains classification under SMF. This will not only provide much-needed clarity but also ensure level playing field for the mutual funds that are investing more than 35% of their total proceeds in overseas mutual funds/ ETFs which, in turn, invest
in equity shares.
In recent years, mutual funds have significantly widened their reach, channelling domestic savings from local participants in the capital markets. Announcing such measures would demonstrate the government’s commitment to fostering wider participation, creating a more equitable environment for both equity and debt markets, and incentivising even the smallest of investor contributions.
As we look back to 2024, the country has achieved several positive milestones and on path to become third largest economy in next couple of years. For keeping the pace of the growth trajectory, it is essential to take the steps that will enhance the faith of foreign, as well as Indian retail investors in the policies and tax proposal in Budget 2025. It is hoped that the upcoming Budget will address the needs of this sector, ensuring that the policies for the financial services space promote sustained growth and development.
By Manoj Purohit, Partner & Leader, Financial Services Tax, Tax & Regulatory Services, BDO India
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