Budget 2025: Your guide to AMFI's 15 mutual fund proposals for investors

As the Union Budget for fiscal year 2025-26 approaches, the Association of Mutual Funds in India (AMFI) has presented a well-structured 13-point proposal aimed at enhancing the mutual fund industry and promoting investor participation. These recommendations include a request for restoration of long-term indexation benefit for debt schemes which was withdrawn in Budget 2024 and earlier tax rates on capital gains.

 

1. Reintroduction of Long-Term Capital Gains Indexation

Objective: The first and foremost proposal from AMFI is to reinstate the long-term capital gains indexation benefit for debt mutual funds.

 

Rationale: Previously, this provision allowed investors to adjust their capital gains according to inflation, providing a more accurate reflection of real returns. The removal of this benefit in the July 2024 budget was seen as detrimental to long-term investors in debt mutual funds. Restoring this indexation would not only enhance investor returns but also promote a stable investment environment.

 

 

Additionally, the proposal seeks to enhance the Mutual Fund Distribution ecosystem by encouraging a higher commission structure for financial advisors, thereby incentivizing them to promote mutual fund investments to a wider audience. AMFI also suggests measures to simplify KYC (Know Your Customer) processes to attract new investors, particularly from underrepresented segments of the population. Other noteworthy recommendations include promoting mutual funds in government-sponsored schemes, increasing awareness about systematic investment plans (SIPs), and encouraging the digital transformation of the industry. 

 

2. Request to restore the earlier tax rates on Capital Gains

 AMFI requested that Capital gains on redemption of Units of Debt oriented mutual funds held for more than 1 year should be taxed at the rate of 12.5% , as applicable in respect of listed bonds.

 

The request is to align the tax treatment of debt mutual funds with that of listed bonds, allowing capital gains on units held for more than 12 months to be taxed at the 12.5% long-term capital gains rate. This change is crucial for encouraging retail investor participation in the debt market, which remains underdeveloped in India. 

 

The proposal emphasizes that treating mutual fund units as “securities” for tax purposes would encourage a more liquid and well-functioning debt market. By harmonizing the tax treatment across similar financial instruments, the government can foster greater investor confidence and participation, ultimately supporting economic growth and providing individuals with better investment options. Aligning the tax rates is not only logical but also necessary for developing a balanced financial ecosystem in India.

 

Current Situation: The Finance Act, 2023 raised Short Term Capital Gains (STCG) tax from 15% to 20%, increasing tax liability by 30%. Similarly, Long Term Capital Gains (LTCG) tax was increased from 10% to 12.5%, raising tax liability by 25%.

 

The Ask: The proposal  requests the government to revert to the previous capital gains tax rates. The significant hikes in tax rates could deter investors from choosing mutual funds.

 

Reduction in STT for Arbitrage Funds and Equity Savings Funds

Current Situation: The STT has been increased significantly for futures and options trading, with rates rising from 0.0125% to 0.02% for futures and from 0.0625% to 0.1% for options. This hike raises the cost of transactions for mutual fund investors.

 

The Ask: The proposal seeks a reinstatement of the earlier STT rates for futures and options used by Arbitrage Funds and Equity Savings Funds. These funds often rely on futures and options for hedging, and the increased STT combined with higher capital gains tax is likely to diminish available arbitrage opportunities, ultimately increasing costs for investors.

 

3.  Request to amend the definition of Equity Oriented Funds to include Fund of Funds investing in Equity Oriented Funds

 

The proposal seeks to amend the definition of "Equity Oriented Funds" (EOFs) to include Fund of Funds (FOFs) that primarily invest in equity-oriented mutual funds. This change is essential for addressing discrepancies in tax treatment that currently disadvantage FOFs compared to direct investments in equity.

 

Current Definition and Issues

Under the existing Income Tax regime, a FOF is considered an EOF only if it meets two criteria:

 

At least 90% of its total proceeds must be invested in units of EOFs.

The underlying EOFs must invest a minimum of 90% of their proceeds in equity shares of domestic companies listed on recognized stock exchanges.

 

While many FOFs meet the first criterion, they often do not meet the second due to the flexibility that EOFs have, allowing them to invest between 65% to 100% in equities. As a result, FOFs that invest heavily in equity securities do not receive the same favorable long-term capital gains tax treatment as direct equity investments or EOFs.

 

The Proposal

Amend the Definition: The proposal requests that the definition of EOF be revised to include FOFs that invest a minimum of 90% of their corpus in units of EOFs, which in turn invest at least 65% in equity shares of domestic companies.

 

Tax Treatment Equality: It is requested that gains from the redemption of units in these FOFs be taxed similarly to those from direct equity investments, which are subject to long-term capital gains tax, provided the holding period requirements are met.

 

Clarification on Section 50AA: The proposal also asks for a clarification from the Central Board of Direct Taxes (CBDT) that mutual fund schemes (including FOFs) investing over 35% of their assets under management (AUM) in domestic equity shares should not fall under the short-term capital gains classification introduced by Section 50AA.

 

"Currently, gains from investing in overseas mutual funds or ETFs through equity Fund of Funds (FoF) are considered short-term capital gains, making these investments less attractive. However, since the investments by overseas equity

oriented mutual fund / ETFs are primarily being made in the equity shares of a company, a clarification that such mutual fund schemes will not be considered as Specified Mutual Fund would bring much relief. This clarification would ensure parity, given that the mutual funds are investing more than 35% of their total proceeds in overseas mutual funds/ ETFs which, in turn, invest in equity shares," said AMFI in its proposal. 

 

4. All Mutual Funds should be allowed to launch pension-oriented MF schemes (MFLRS) with Uniform Tax Treatment as NPS

All SEBI registered Mutual Funds should be allowed to launch pension-oriented MF schemes, namely, ‘Mutual Fund Linked Retirement Scheme’ (MFLRS), with similar tax benefits as applicable to NPS under Sec. 80CCD (1) & 80CCD (1B) of Income Tax Act, 1961, with ExemptExempt-Exempt (E-E-E) status on the principle of similar tax treatment for similar products.

 

Allowing Mutual Funds to launch MFLRS would bring pension benefits to millions of Indians in the unorganized sector. Going forward, pension funds will emerge as sources of funds in infrastructure and other projects with a long gestation period, as well as for providing depth to the equity market (perhaps looking for absorbing stocks arising out of disinvestment program of the government).

 

5. Mutual Fund Units should be notified as ‘Specified Long-Term Assets’ qualifying for exemption on LTCG

 

The Proposal

Inclusion of Mutual Funds: The proposal suggests that mutual fund units, especially those investing in specified infrastructure sectors defined by the government, should be recognized as specified long-term assets under Section 54EC.

 

Investment Criteria: The mutual fund units should invest in infrastructure assets, as outlined by the Reserve Bank of India, and have a mandatory lock-in period of three years to qualify for the tax exemption.

 

Justification

Supporting Infrastructure Development: The government plans to significantly ramp up infrastructure investment, which will require substantial funding. The current options, primarily bonds from REC and NHAI, may be insufficient and offer lower returns that might not appeal to investors.

 

Market-Linked Returns: Allowing mutual funds to qualify for tax exemptions under Section 54EC would provide investors with an opportunity to earn market-related returns while supporting infrastructure projects.

 

Channeling Gains into Capital Markets: This tax benefit would encourage individuals to reinvest gains from the sale of immovable properties into mutual funds, thereby boosting investments in infrastructure and supporting the government's initiatives.

 

6. Proposal to Increase the Threshold Limit for Withholding Tax (TDS) on Income Distribution by Mutual Fund Schemes

This proposal seeks to raise the threshold limit for withholding tax (Tax Deducted at Source, or TDS) on income distributions from mutual fund schemes for resident investors, from the current limit of Rs 5,000 to Rs 50,000 per annum.

 

Background

Current Regulations: Under Section 194K of the Income Tax Act, TDS is applicable on income distributions (dividends) made by mutual fund schemes to resident investors when the total amount exceeds Rs 5,000 in a financial year.

 

Impact on Retail Investors: The existing threshold of Rs 5,000 is considered low, particularly for retail investors, especially those in lower income brackets. When investors receive dividends exceeding this limit, TDS is deducted, which can create a financial burden as they must subsequently file for a refund in the following assessment year (AY).

 

7. Request for relaxation to the mutual funds in case of deduction of TDS for inoperative PAN cases

AMFI has requested that CBDT should clarify that mutual funds are not required to deduct TDS at higher rates in case PAN becomes inoperative if the PAN was valid when the investor was onboarded by the mutual fund AMC. 

 

8. Request for Amendment to ELSS Rule 3A: Allowing Flexible Investment Amounts

The proposal seeks to amend Rule 3 of the ELSS to eliminate the requirement that investments must be made in multiples of Rs 500. Instead, it suggests allowing any investment amount, provided it meets the minimum threshold of ₹500. This change would create a more investor-friendly environment, allowing individuals to invest according to their financial situations without being constrained by arbitrary multiples.

 

9. Exemption from Capital Gains Tax for Switches between ELSS Schemes

Proposal: Exempt capital gains tax on switches between ELSS schemes.

Justification: This would encourage investors to optimize their portfolios without incurring additional tax liabilities.

 

10. Simplification of Taxation for Mutual Funds

Proposal: Standardize the tax treatment of all mutual fund schemes to promote clarity and simplicity.

Justification: A simplified tax structure would enhance investor confidence and participation in the mutual fund market.

 

11. Inclusion of AIFs in the Tax Exemption Framework

Proposal: Extend the tax exemption framework to Alternative Investment Funds (AIFs).

Justification: This would enhance the appeal of AIFs and attract more investments into this sector.

 

12. Encouragement of ESG Investments

Proposal: Introduce tax incentives for investments in ESG-compliant mutual funds.

Justification: Promoting environmental, social, and governance-focused investments aligns with global trends and investor preferences.

 

13. The proposal for a Debt Linked Savings Scheme (DLSS) aims to expand India's corporate bond market by encouraging retail investors to channel their long-term savings into higher-rated debt instruments. 

Drawing inspiration from the Equity Linked Savings Scheme (ELSS), the DLSS would offer tax benefits for investments up to Rs 1,50,000, with a five-year lock-in period. By mandating that at least 80% of the collected funds be invested in corporate bonds and debentures, the scheme seeks to reduce reliance on traditional banking for corporate financing. This initiative not only aims to deepen the bond market but also supports the government's infrastructure financing goals, creating a more robust financial ecosystem.