It may seem strange that the Association of Mutual Funds of India (AMFI) should come up with a long Budget wish-list for this year after the Centre’s proposals to simplify and standardise the tax regime for investments in the July 2024 Budget. But the AMFI wish-list shows that the ‘simplified’ tax regime has dealt an unfair hand to those favouring fixed income instruments. For debt fund investors, changes in the last two Budgets have resulted in both capital gains and interest income getting taxed at their default income tax slab rate.

A retrospective element to taxation was also introduced last year, where indexation benefits on capital gains from debt fund investments made before April 1, 2023 were removed, subjecting all returns from legacy investments to tax at the slab rate. As AMFI has pointed out, debt fund investors typically make returns of about 7 per cent a year. Taxing these returns at the slab rate results in a negative real return to investors. Besides debt-oriented mutual funds, all fixed income investors — whether they opt for bank deposits, corporate fixed deposits, small savings schemes, corporate bonds or government bonds — are in the same boat. This is leading to several distortions.

For one, the unfavourable tax treatment of returns on debt instruments versus equity capital gains has skewed retail asset allocation towards the risky stock market, while savings in safer debt instruments are declining. The share of debt fund assets in the mutual fund industry has shrunk from 32 per cent to 27 per cent between December 2022 and December 2024, while equity funds have seen their share increase from 58 to 61 per cent. Asset allocation decisions should ideally be based on the individual risk appetite of investors — but taxation now seems to be influencing this choice. Two, fixed income investments such as deposits and small savings schemes are bread-and-butter investments for majority of households. Therefore, negative real returns on these instruments take away the raison d’etre for saving itself. It is not surprising that households’ savings in financial assets have been flat-lining in recent years, even as they are rising in gold and real estate assets. Three, punitive taxation on fixed income instruments hits vulnerable sections of population – be it the young earner parking money in recurring deposits or the retiree subsisting on passive income. Finally, healthy household deposit flows are critical to our infrastructure building ambitions. These cannot take wing without retail participation in deposits, bonds and debt mutual funds.

The Centre must initiate corrective steps to lighten the tax burden on fixed income instruments. It must move to a flat rate for fixed income instruments that allows for a positive real return. Debt avenues favoured by vulnerable sections such as post office schemes and senior citizen deposits, must be exempted from tax.

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