Recent tax reforms have significantly reduced the long-term benefits of indexation for debt mutual funds, prompting industry calls for relief ahead of the FY 2026-27 budget to safeguard conservative investors’ returns.
Indexation, which adjusts an investment’s purchase price for inflation, once gave debt mutual funds a meaningful tax edge. By increasing the base cost, it reduced the taxable gain when units were sold. That advantage has been sharply curtailed by changes brought in over the past two budget cycles, leaving many fixed-income investors with far less relief than they had under the older rules.
Under the previous framework, debt funds held for more than 36 months could qualify for long-term capital gains tax at 20% with indexation. The Finance Act 2023 removed that benefit for units bought on or after April 1, 2023, so gains on newer purchases are now taxed at the investor’s slab rate regardless of how long the money stays invested. Then the Budget 2024 changes narrowed the treatment further for older holdings: units bought before April 1, 2023 and redeemed after July 23, 2024 now face a 12.5% long-term capital gains rate after a 24-month holding period, but without indexation.
That shift has reduced the appeal of debt funds for conservative savers, especially those in higher tax brackets. According to Value Research and other industry observers, the removal of indexation has weighed on net inflows into the category over the past three years, while also narrowing the tax gap between debt funds and fixed deposits. For investors who had used debt schemes as a low-volatility, tax-efficient park for long-term savings, the revised rules have changed the calculation materially.
Ahead of the Union Budget for FY 2026-27, the Association of Mutual Funds in India has renewed its call for relief. The Economic Times reported that AMFI has put forward a 27-point budget wish list, including the restoration of long-term indexation benefits for debt funds. AMFI says the move would improve after-tax returns for cautious investors, particularly retirees, and help redirect household savings into the corporate bond market. The association’s proposal, set out in its budget submission, seeks amendments to sections of the Income Tax Act including sections 2, 48, 50AA and 112.
For now, however, the tax position remains unchanged. New debt-fund purchases are still taxed at slab rates, and the post-July 23, 2024 framework leaves no indexation benefit in place. That means the key issue for investors is not just how long they hold a fund, but also when the units were bought and when they are redeemed.
Disclaimer: This article is intended to inform and educate, not to recommend or endorse any financial product, investment or strategy. Please consider your own financial circumstances and seek professional advice where appropriate before making financial decisions.
