For a long time, debt funds and equity funds had their own loyal clientele. The demand for debt funds used to be higher since conservative individual investors as well as institutions had a huge appetite for debt. However, several things change for debt. Firstly, consistently lower rates of returns made debt unattractive to investors, and pushed many investors into equities, despite the higher level of risk. Then debt funds started to be taxed at a higher rate of tax compared to equity funds. But the last straw came about two years back when the CBDT removed LTCG benefits entirely and treated any fund with more than 65% exposure to debt at par with savings accounts and other deposits. 

In the last 10 years, investors have consciously moved away from debt towards equity for a number of reasons. Interest rates have fallen, options are limited, some of the debt funds triggered major losses for clients, and tax benefits have been largely withdrawn. Ideally, asset allocation has to happen predominantly across debt and equity and then it has to allocate a smaller share to other assets. However, the challenge today is that debt is just not an attractive proposition in post-tax terms. This forces many investors to allocate larger portions of their wealth to equities, which may not be the most optimal thing to do. Debt funds need a level playing field to play a key role in asset allocation. 

The AMFI has been persistently demanding level playing field, but each budget has only made life tougher for debt funds. While equity funds have to be held for 12 months to qualify as LTCG, debt funds must be held for 24 months. Even here, the short-term gains on debt funds are much higher. However, the real unfair treatment is meted out to the pure debt funds that invest more than 65% of their corpus in debt. Here there is no concept of LTCG and STCG and even if the debt fund is held for 5 years, the gains will be treated as other income in the year of sale and taxed at the peak incremental rates of tax. Not to forget that even the limited benefit of indexation for debt funds was removed. 

This is not as complex as it appears. Today, a listed bond becomes long term capital asset if it is held for just one year. However, in case of a pure debt fund, holding these bonds, the tax is levied at the incremental rate. Secondly, there has been a fair demand that the base exemption of ₹1.25 lakhs from capital gains tax given to equity funds, should be extended to debt funds also. This will encourage rational and intelligent asset allocation by investors. Above all, there also demands for a DLSS tax saving scheme on the lines of ELSS funds, to help small investors begin their mutual fund journey through tax saving conservative schemes. It is time for better treatment to debt funds!