Principles underlying tax architecture need wider debate

Source- The post is based on the article “Principles underlying tax architecture need wider debate” published in “The Indian Express” on 28th March 2023.

Syllabus: GS3- Government budgeting

Relevance– Issues related to taxation

News– Recently, the Finance Bill 2023 was passed by voice vote in the Lok Sabha last week with 64 amendments.

What is the contentious decision related to amendments?

There was a decision to scrap the tax benefit for debt mutual funds. From April 1, investors in debt mutual funds cannot avail the benefit of indexation for calculation of long-term capital gains.

These investments will now be taxed at income tax rates applicable to an individual’s tax slab.

What is the meaning of indexation for calculation of long-term capital gains?

Indexation means adjusting the cost of funds by taking inflation into consideration. It is offered to debt fund investors if the investment is redeemed after 36 months.

In the case of debt funds, long-term capital gains were taxed at 20% with indexation benefits. This benefit brought down an investor’s tax liability.

What will be the impact of the decision to scrap the tax benefit for debt mutual funds?

There are concerns that the withdrawal of the benefit will affect investors. They will reassess their allocations to debt mutual funds. This may impact flows into these funds.

Debt mutual funds channel funds into the bond market. This move may be detrimental to the growth and development of the bond market in India.

According to a report by Crisil, 70% of the investment in debt funds flows from institutional investors. Individual investors accounted for 27%. This will possibly affect flows to the corporate bond market and thus demand for corporate debt is likely to be impacted.

The difference between bank deposits and debt funds needs to be considered. Bank deposits are insured up to Rs 5 lakh. Debt mutual funds do carry risk depending on the risk profile of the bonds they hold.

What is the way forward for taxation structure in India?

Capital gains architecture in India needs to be reexamined and reconfigured. There are different rates of taxation for different asset classes. Rationalisation of tax rate and the holding period is desirable.

The principles underlying the tax architecture in India need to be widely discussed and debated.