Arbitrage, equity savings funds gain favour among rich investors

Fund houses have launched debt-arbitrage FoFs to attract investors in higher tax brackets

- SANJAY KUMAR SINGH & KARTHIK JEROME

The Union Budget of 2023 removed the indexation benefit on capital gains from debt mutual funds (MFs). This had a far-reaching impact not only on the category but also on investor behaviour.

How tax rules changedUntil March 31, 2023, gains from debt MFs held for over three years were treated as long-term capital gains (LTCG) and taxed at 20 per cent with indexation. Gains from holdings up to three years attracted tax at slab rates.

From April 1, 2023, all gains are taxed at slab rates, regardless of holding period. Initially, units purchased on or before March 31, 2023, were grandfathered: if held for over three years, they continued to qualify for LTCG treatment. The 2024 Budget revoked this. For such units, the LTCG threshold was reduced to two years, and the tax rate revised to 12.5 per cent without indexation. As a result, units bought before April 1, 2023, and redeemed on or after July 23, 2024, are taxed at 12.5 per cent if held over 24 months, or at slab rates otherwise.

Impact on flowsDebt fund assets under management (AUM) rose 48 per cent between March 2023 and June 2025. "This is because whatever tax advantage debt funds enjoyed vis-à-vis bank FDs and other fixed-income instruments was taken away, and they were brought on a par with them. But it is not as if debt funds were placed at a disadvantage in terms of tax treatment," says Joydeep Sen, corporate trainer (debt markets) and author.

He adds that most investments in liquid, money market, or short-term funds anyway didn't stay invested long enough to benefit from indexation, hence the change had limited impact on these categories.