Tax on debt MFs. Lower-rated corporates may find it difficult to raise resources

Raising resources via bonds could prove an uphill task for lower-rated corporate and non-banking finance company (NBFC) issuers as inflows into debt schemes of mutual funds may slow in view of new taxation rules.

As per the new taxation rules, income from debt funds having not more than 35 per cent invested in equity shares would be treated as capital gains, irrespective of their holding period, and taxed at the income tax slab level from April 01, 2023.

“Retail investors don’t buy corporate bonds because it is difficult to understand these instruments. The main investors in these bonds are mutual funds. If retail investors stop putting money in MF debt schemes then who is going to buy the corporate bonds? MFs create liquidity in the secondary market by buying and selling these bonds,” said Madan Sabnavis, Chief Economist, Bank of Baroda.

Mutual fund industry experts opine that if there is a slowdown in inflows of debt schemes of mutual funds, lower-rated corporates (those rated ‘A’ and below) may find it difficult to raise funds via bonds. 

“Withdrawal of tax (long-term capital gains) benefit for investors in debt MF schemes will impact the bond market. If the government wants retail investors in the government securities and corporate bond market then it should get about it,” they said.

Finance Bill 2023: How will it impact mutual fund investors?  Finance Bill 2023: How will it impact mutual fund investors?  

Chirag Mehta, CIO, Quantum AMC, observed that debt mutual funds play a key role in price discovery and liquidity of Indian bond markets.

“With lower incremental flows expected into duration debt funds going forward, this tax change will be a setback for the development of our bond markets.

“However, the benefit of debt funds where they are taxed only on redemption against fixed deposits that are taxed on an accrual basis still makes it a good proposition for investors, ” Mehta said.

Challenges

Experts say that removal of long-term capital gains tax benefits on debt mutual funds will pose challenges for the corporate bond market because mutual funds were not just investors but also traders.

Retail investors usually buy government securities through gilt funds because they get tax benefit and liquidity.

Also read: What the debt funds tax change means for investors

“Earlier, an ‘A’ rated company would have still been successful in raising money from the market as mutual funds will take a risk if they think it will not default. Insurance companies will only buy highly rated bonds.

“An individual investor may not put money in an ‘A’ rated debenture, but MFs will invest as they have better risk assessment and want to diversify their portfolio,” Sabnavis said.

According to experts, bond market will be pushed back once investors start withdrawing from debt schemes of mutual funds.

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