Bad Karma Taxes
There's evidence that the Indian Government had assured the benefit of indexation to debt fund investors, something that it seems to have completely forgotten.
The Indian Government has decided to partially roll back the withdrawal of indexation in calculating tax on capital gains on sale of land and property.
That’s something.
But it seems that the Government still doesn’t comprehend how devastating its changes have been for taxpayers who have invested in debt funds.
That’s not all. There’s something much more glaring that’s come to light.
A large number of taxpayers made investments in debt funds on the explicit assurance by the Indian Government that they would be eligible for inflation indexation while calculating the tax on their capital gains.
Yes.
In fact, the Government promoted these debt funds, assuring lower taxes thanks to the “benefit of indexation”.
Hard to believe?
Read on.
In December 2019, the Indian Government announced the launch of the Bharat Bond series of Exchange Traded Funds (ETFs). To quote from the press release:
The Cabinet Committee on Economic Affairs… has given its approval for creation and launch of Bharat Bond Exchange Traded Fund (ETF) to create an additional source of funding for Central Public Sector Undertakings (CPSUs) Central Public Sector Enterprises (CPSEs), Central Public Financial Institutions (CPFIs) and other Government organizations.
The press release went on to list several benefits of the initiative, that included the following (emphasis added):
Bond ETF would offer CPSEs, CPSUs, CPFIs and other Government organizations an additional source of meeting their borrowing requirements apart from bank financing.
It will expand their investor base through retail and HNI participation which can increase demand for their bonds. With increase in demand for their bonds, these issuers may be able to borrow at reduced cost thereby reducing their cost of borrowing over a period of time.
This is expected to eventually increase the size of bond ETFs in India leading to achieving key objectives at a larger scale - deepening bond markets, enhancing retail participation and reducing borrowing costs.
The press release also cited a few benefits for investors, prominent among which were the following (emphasis added):
Bond ETF will provide safety (underlying bonds are issued by CPSEs and other Government owned entities), liquidity (tradability on exchange) and predictable tax efficient returns (target maturity structure).
Tax efficiency compared to Bonds as coupons from the Bonds are taxed at marginal rates. Bond ETFs are taxed with the benefit of indexation which significantly reduces the tax on capital gains for investor.
Those last few words are worth repeating.
…taxed with the benefit of indexation which significantly reduces the tax on capital gains for investor.
To cut a long story short, the initiative was a runaway success, and the Government accomplished on a grand scale what it hoped for, by way of low cost borrowing. As on date, there are 5 Bharat Bond ETFs, 3 other Bond ETFs, and 82 Target Maturity Debt Index Funds that have invested, altogether, over Rs. 180,000 crore across Government securities, PSU bonds, and State Development Loans.
But what exactly have the investors in these debt funds got in return?
Table 1 below shows the returns generated by the three Bharat Bond ETFs that have been in existence for three years or more, as on 31 July 2024.
Investors in Target Maturity Funds are expected to stay invested until maturity, so usually it’s pointless to look at returns midway. However, with the changes in Budget 2024, many investors will find it better to exit before that, so as to minimize their taxes. Unfortunately, the taxes are going to be much steeper than what they would have been under the rules prevailing before Budget 2024.
Let’s say that a taxpayer invested Rs. 10 lakh at inception, in each of these three Bharat Bond ETFs. Let’s further say that this taxpayer exited these investments on 31 July 2024. Table 2 shows how much taxes this person will have to pay, based upon the changes announced in the Budget, compared to what would have been paid, had these changes not been made.
Thanks to the availability of indexation, debt funds have been the only investment avenue that allowed risk-averse taxpayers a chance of holding out against inflation. Not any longer.
By removing indexation, the Government has left these taxpayers defenceless against inflation.
As for those who invested specifically in Bharat Bond ETFs and Target Maturity Funds, they took the Government’s word on “tax efficient returns” at face value and funded the Government to the extent of over Rs. 180,000 crore.
To them, the Government’s changes represent a savage betrayal as well.
Betraying someone’s trust, especially someone who helps you, is a guaranteed way of earning bad Karma.