How to deal with this unfair tax

[View this in your browser]( [Editors note](?utm_source=2019-12-17-editors-note&utm_medium=email&utm_campaign=stock-insight) MARCH 24, 2023 Dear Value Research Member, A tax shock is coming the way of debt fund investors soon. Let’s discuss how to deal with it. It appears that shortly before it is to be passed, the Government has inserted an amendment into this year’s budget that indexation will not be available for investments in debt funds, gold funds and some classes of hybrid mutual funds. Effectively, all those mutual funds which have less than 35 percent equity component will have no such thing as capital gains. No matter how long you hold them for, when you sell them the gains will just be added to your income in that year. Thus, it will be taxed at whatever income tax slab you are in. This will have a huge impact on the tax you pay because indexation will no longer be available for calculating your gains. Note that indexation of capital gains is essentially inflation-adjustment. It is not a tax exemption, nor is it a gift from the government. It is a compensation for inflation, for the fact that the value of money degrades over time and much of the so-called gains over the years are just an illusion. This illusion is created because today, money is worth inherently less than what it was worth when you invested. This degradation of money is in any case a side-effect of the action of governments. Any illusory gains that you get from inflation should not be taxed. Inflation takes an enormous chunk out of your gains and indexation just compensates for it. Let’s take a real example. The current average three-year returns of Medium Term Debt funds, as listed on Value Research Online are 6.56 percent p.a., which is a total gain of 21 percent over the period. If we look at the cost inflation index on the Income Tax Department’s website we find that the index has increased from 289 to 331 over the period, a gain of 14 percent. If we apply the index to our example funds, the real taxable gains are not 21 percent but just 5.6 percent. If indexation is not available, and you are in the top tax bracket, practically all your real gains will get taken away by the government. Part of your money will be eaten away by inflation, the rest taken away as tax. What to do about it Of course, the first thing to do is to wait and see the actual details after the change is notified. However, there are a few mitigation strategies that are there. Debt Funds: Vis-a-vis bank fixed deposits, debt funds still make more sense. There are two reasons for this. The biggest is that returns in debt funds accumulate and compound, while in FDs they do not. In FDs, TDS on interest is charged every quarter and transferred out. In mutual funds, the tax is deferred till redemption. Thus, even if the rate of return is nominally the same, you earn more in a fund. The second reason is that there is better liquidity. You can redeem a debt fund any time. With a deposit, you have to pay a penalty for withdrawal. For some types of deposits, an early withdrawal is not possible. Tax free alternatives: There are many such options for your fixed income needs. For example, PPF, EPF and NPS. Earlier, you may not have bothered much but now you must use these to the fullest extent possible. Domestic Funds with foreign equity: Apart from debt, international funds have also been affected by this change. However, since the law exempts all those funds that have 35 percent or more of domestic equity, you can shift to funds that have domestic equity along with international equity. Gold Bonds: If you were investing in Gold funds, then the logical choice is Sovereign Gold Bonds. [Here are all the details in an earlier article that we had carried on Sovereign Gold Bonds](. Of course, it would have been best if this change had not taken place, but now that it has, there are ways of dealing with it. Regards Dhirendra Kumar Editor FOLLOW US [[Twitter]Twitter]( [[Facebook]Facebook]( [[Youtube]Youtube]( [[LinkedIn]LinkedIn]( Copyright © 2023 Value Research India Pvt Ltd. All rights reserved. Please read our [Privacy Policy.]( C-103, Sector 65, Noida Uttar Pradesh 201301, India This notification mail has been sent to you at {EMAIL} because you are a member of Value Research Online. [Add more newsletters]( | [Change your email]( | [Unsubscribe from this newsletter](