How the Union Budget Affects Mutual Funds

Budget is an annual event introducing and altering crucial norms for taxation, investments and overall governance. Mutual funds, being one of the most desired investments in India, are significantly affected by this. The budget impact on mutual funds is visible mainly in terms of tax changes, regulations and market reaction to these changes.

Understanding the mechanism of this impact can help investors be aware of their existing investments, tap new opportunities and manage this effect on their portfolios. 

Impact of Budget on Mutual Funds

A budget is a fiscal document planning for allocations, expenditures, projects and policies for the upcoming financial year. It affects almost all the aspects of an economy, including mutual funds. There are different categories for mutual fund investments. Budget impact on a mutual fund category can be based on the weightage of specific assets in the scheme. 

For example, in the debt fund category, more effect is evident in the monetary policy changes, rather than fiscal policy changes.

Therefore, the following impact can be significant for mutual fund investments:

Direct Tax Changes

The budget is liable for potential changes in the income tax. Mutual fund investments are mainly taxed for: 

• Capital gains earned in their redemption 
• Dividend income under the Income Distribution and Capital Withdrawal (IDCW) option. 

In this, capital gain taxes are considered under the direct tax head. It significantly impacts the mutual fund investment for existing and potential investors. Moreover, based on these tax rates and policies, investor preferences shift among the categories. 

For example,

• When the indexation benefit was removed for debt funds in Budget 2024, the potential tax liability on the debt fund redemption increased. 
• Due to this, data indicates a reduction in the investor’s preference for debt funds. 
• The monthly debt fund redemptions have increased by nearly 20% up to December 2024 since this budget announcement.

Indirect Tax Changes

The tax paid by individuals based on their consumption indirectly is known as indirect tax. Some of its common examples are:

• Custom duty 
• Goods Service Tax (GST) 
• Tax Deducted at Source (TDS)

In mutual funds, investors receive dividends under the IDCW option after deducting this TDS. 

Previously, TDS was also applicable on redemption. However, it was removed in the Budget 2024. Such taxes can impact the transactions in mutual funds, and investors may decide their holdings based on such implications.

Regulatory Changes

The budget is a crucial document for establishing regulatory norms for the next financial year. The government has a broader view while deciding these norms, and it can eventually drive the investor’s preferences. 

For example, 

• In the Budget 2023, a new tax regime was introduced, with wider slabs and more suitable tax rates. 
• However, all deductions were cancelled in this regime. 
• The Equity-Linked Savings Scheme (ELSS), an equity funds category providing deductions under Section 80C, was adversely affected by this category. 

Market Sentiment

Being an investment with market exposure, budget impact on mutual fund schemes is potentially specific. Changes in budget can affect a particular sector, services or products, which can ultimately affect the mutual fund schemes investing in them. 

For example, 

• In budget 2024, the objective of regulators to promote long-term investment was evident. 
• Market sentiment was a reflection of this objective for some categories. 
• Since the budget announcement, the folios under the long duration funds surged by more than 25% up to December 2024.

Budget 2024-25 Impact on Mutual Funds

The impact of this budget on mutual funds was crucial in many terms. Taxation norms, regulations and definitions were. Some of these norms are as follows:

• Capital gains tax rates and holding periods based on the investment type were changed. Short-term gains tax was increased.
• Tax Deducted at Source (TDS) was removed from the mutual fund redemption.
• Indexation benefits were removed from the debt mutual funds.
• Categorisation of ‘Specified Mutual Fund’ for taxation purposes.

Investors were demotivated for short-term investments in this budget. Moreover, the high tax liability on the investments became a concerned topic.

AMFI Expectations for Budget 2025-26

The Association of Mutual Funds in India, or AMFI, is a body protecting the rights of mutual fund investors. It has presented certain expectations regarding the upcoming budget 2025-26, as of January 15, 2025. 

Some of the crucial points in this list are as follows:

• Change of capital gains taxation to the previous tax rates.

If implemented, it will help attract more investors. Mutual funds are an instrument desired for its diversification, exposure and simplicity. Therefore, relaxing tax norms can help investors retain a significant part of their gains.

• Long-term indexation for debt funds.

This benefit can help investors account for the inflation effect. It will reduce their notional gains and ultimately help reduce the tax liability.

• Simplification of tax provisions for off-shore investments.

If this expectation is approved in the budget, the mutual fund industry can attract significant off-short investments. It will instil more confidence in the asset, launch new schemes and get better diversification in the market.

• Increase the limit for TDS applicability in mutual funds income and many more.

As of January 2025, the TDS is applicable on dividend income above ₹5000. AMFI proposes to increase it to ₹50,000 that will help investors earn significant extra income over mutual fund gains.

The body seeks to make these provisions to safeguard investor’s interests and attract them towards mutual funds.

Conclusion

Mutual fund investments are growingly becoming popular in the country. Therefore, the impact of budget on mutual funds can be significant in terms of direct or indirect tax changes, regulations and overall market sentiments. Investors can understand this effect in detail to pre-determine the potentially affected schemes and invest accordingly.