The upcoming Union Budget 2026, should offer respite to debt mutual funds, relieve the capital gains tax burden to assist with long-term retail investor participation, Indian mutual funds have emphasised through their wish list.
In lieu of capital gains taxation hit to mutual fund investors on multiple fronts, the Association of Mutual Funds (AMFI) has requested for restoration of long-term capital gains tax with indexation benefit to assist and encourage investors to stay invested for a longer duration.
Currently, the indexation benefit has been discontinued and all investment gains after the holding period of 1 year face a capital gains tax of 12.5%.
As a result, the debt mutual funds category is bleeding money and deterring long-term participation in fixed income after the decision to tax gains from debt mutual funds at the slab rate irrespective of the holding period.
“Debt remains a vital investment class for conservative investors who depend on it for income and relative stability eg. senior citizens. Channelling Retirement savings into fixed income is key to ensure senior citizens’ and retirees’ investment requirements can be suitably met,” states the mutual fund trade body in its Budget recommendations to the Finance Ministry in 2026.
Industry experts agree that the tax rationalisation would revive the category of safer investments of debt funds, compared to equity assets, which have a higher risk. Additional, leeway in the capital gains tax limit needs to be considered.
“Rational tax treatment for debt funds is needed apart from raising the equity long-term capital gains exemption limit from Rs.1.25 lakhs in a year,” says Hemant Rustagi of mutual-fund distribution firm Wiseinvest. A request has been officially made to enhance the threshold of capital gains to ₹2 lakh from 1.25 lakh currently.
Capital Gains Tax leeway
The investor stickiness in mutual funds is tied to the taxation rate, which is reducing to 12-24 months as the long-term capital gains are now applicable after the holding period of 1 year. The industry has proposed that the long-term capital gains tax be levied at 12.5% for funds redeemed between 1-3 years and the tax on gains be exempted for investments held for more than 5 years.
“Currently due to the standard rate of tax post holding period of 12 months / 24 months as the case may be, most investors redeem their investments after the said period,” mentions one among the 27Budget suggestions of AMFI.
The industry has also requested that tax exemption be granted to switches from direct plan to regular or even switches to rebalance the portfolio from one scheme. This is in line with switches under the competitive category of Unit-Linked Insurance Plans, where switches from one fund to another are exempt from taxes.
“There is disparity between tax treatment on switching of investment within a Mutual Fund scheme and within a ULIP of Insurance companies, although both MF schemes and ULIPs invest in securities and are investment products,” states AMFI.
This leads to tremendous capital loss for mutual fund investors.
As Rustagi says, “There shouldn’t be capital tax on intra-scheme switches as well as switches
effected to rebalance the portfolio within funds considered as equity funds for taxation purpose.”
Scheme winding up
Similarly, when a scheme is wound up due to fewer investors or a category of funds being obsolete, again investors need to pay capital gains tax, even though they need to forcefully move to another fund. The same needs to be removed as it is an involuntary switch from one fund to another.
Tax-saving Debt Mutual Funds
Currently retail investors have no incentive to save in long-term fixed-income products apart from Provident Fund accounts. The mutual fund industry has requested that the fresh Debt-Linked Savings
Scheme (DLSS) with a 5-year lock-in and a separate deduction beyond the Section 80C baset be introduced to augment the fixed income portfolio of retail investors.
Additionally, another mutual fund managed voluntary retirement scheme (MF-VRA) plan be introduced for social security benefits, which would invest as per the lifecycle of an individual and can be linked to the employer-associated retirement benefits. “Additional tax deductions or exemptions can be considered to incentivize individuals to contribute to their MF-VRA accounts,” suggests AMFI.
Rebate
While the retail investors who do not have any income of upto ₹12 lakh need not pay any income tax, salaried middle-class individuals earning less than ₹12 lakh to end up paying 12.5-20% tax as they aren’t granted the income tax rebate of ₹60,000, due to the status of special income from capital gains from financial instruments. If the total income (including such gains) does not exceed ₹12 lakh, the rebate should be offered to middle-class taxpayers, who diversify their income through capital market investments ensuring equitable treatment across income sources, suggests AMFI.
“Simplifying the tax treatment across different asset classes will reduce the “tax complexity” that often scares away small-town investors,” says Madhu Lunawat, Founder, MD and CEO, The Wealth Company Mutual Fund.
International investments
It is observed that frequently during the year fund houses need to pause investments into funds that assist investors to invest in international stock markets through the mutual fund route due to exhaustion of the $7 billion investment window limit set by the Reserve Bank of India.
Aditya Agarwal, Co-Founder of wealth management platform, Wealthy.in, says, “When Indian global mutual funds stop accepting fresh investments after nearing the industry-wide overseas investment cap, investors resort to the direct investment route, which could be risky for retail investors. Hence, an expansion of the overall overseas investment window should be considered to help individuals diversify geographical risk.”
Multiples of 500 in ELSS
Fund houses face technical issues when tax-saving mutual funds need to adhere to limits of multiple of ₹500. Investors aren’t aware of these limits and hence some mutual funds are compelled to reject applications or partially refund the excess amount, leading to investors’ inconvenience and increased operational work for fund houses.
The industry body has requested that investments in Equity Linked Savings Scheme be permitted of any amount, subject to a minimum of ₹500.
Surcharge rate cap
Non-resident Indians (NRIs) too face difficulties in tax compliance due to no standardisation with respect to surcharge on TDS. The industry body has requested for a uniform rate of surcharge at 10% on TDS levied on dividend and capital gains from redemptions instead of slab wise rate.
Similarly, income distribution by a mutual fund to regular investors may be subject to a higher surcharge rate of 37% (as it is applicable based on the income slab). The industry has also demanded that surcharge be capped at 15% when mutual funds distribute income, to bring parity between dividends by corporates and income distribution by mutual funds.
Additionally, the Association has demanded extension of the TDS threshold for income distribution to ₹50,000 from ₹10,000, as it causes hardships to individuals in lower income bracket, who have to claim refunds after filing tax returns.
STT Removal
To avoid double taxation to retail investors, the mutual funds association has requested for a relief from securities transaction tax (STT) as long-term capital gains tax has been introduced on mutual fund units. “Investors have to pay STT on the transaction value and again need to pay capital gains tax on the gain realized on the sale transaction, which acts as a barrier for a new investor to invest in mutual funds,” says AMFI.
Increasing the STT on futures and options has adversely impacted arbitrage funds too, which are used by investors to hedge their risk. “The available arbitrage has now been reduced due to an increase in short term capital gain tax. Further, the increased STT on futures will add to the cost of these funds.”