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Bharat Bond ETF vs. ELSS: Govt’s Capital Gains Tax Reform Aims to Bridge the 20% Gap

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In the intricate world of investment, understanding the tax implications of your financial decisions is crucial. The Indian government’s contemplation to revise the capital gains tax structure for debt mutual funds is a significant development that could influence investor behavior and fund performance.

Let’s explore the current challenges, potential changes, and implications with illustrative examples.

Understanding Bharat Bond ETF

The Bharat Bond ETF, launched in 2018, is an innovative financial instrument introduced by the Indian government to enable investors to participate in the debt of public sector companies. It is an Exchange-Traded Fund (ETF) listed on the National Stock Exchange (NSE), which means it can be bought and sold like a stock during trading hours.

Key Features of Bharat Bond ETF:

  1. Public Sector Bonds: The ETF invests your money exclusively in bonds issued by public sector entities.
  2. Fixed Maturity: Each Bharat Bond ETF has a defined maturity date, similar to a bond. At that point, investors receive their principal amount along with the returns.
  3. Exchange Traded: The units of the ETF can be traded on the NSE, providing liquidity and flexibility to investors.
  4. Low Cost: It is managed very cheaply, making it an economical investment option.
  5. Safety and Predictability: Since the fund invests in bonds with high credit ratings (AAA), it offers a safe investment avenue with predictable returns.
  6. Tax Efficiency: Investors enjoy the benefit of indexation, which can significantly reduce the tax on long-term capital gains.

Current Taxation Challenges

The Bharat Bond ETF has been a game-changer for public sector borrowing. However, since April 1, 2023, it has faced a taxation hurdle. The Finance Bill 2023 brought it under the same capital gains tax bracket as other debt mutual funds, where the investor’s income tax slab determines the tax rate. This shift from the previous long-term capital gains tax of 20% with indexation benefits for holdings over 36 months has raised investor concerns.

Let’s understand it better with an example: considering that you invested Rs 1 Lakh in the Bharat Bond ETF 2030, and it grows by the current growth rate of 6.48%, then this is what your returns would look like following: 

Investment in Bharat Bond ETF
Amount in PortfolioGrowth RateCapital GainTotal Capial Gain
Initial Investment 1000006.48%6480
20251064806.48%69006480
20261133806.48%734713380
20271207276.48%782320727
20281285506.48%833028550
20291368806.48%887036880
203014575045750

The profit you gain on maturity can be Rs 45,750, but this can vary due to market fluctuation. According to your tax slab, this would look like a post-tax deduction.

Tax BracketCapital GainCapital Gain TaxProfit After Tax
0%45750045750
5%45750228743462
10%45750457541175
15%45750686238887
20%45750915036600
30%457501372532025

As you move higher in the tax slab, the overall capital gain is lower, making other investment options like the ELSS more attractive for investors. If the same amount of Rs 1 Lakh was invested in ELSS with the category average CAGR of 20.13%, you’ll earn a capital gain of Rs 2,00,545.

And after the 10% long-term capital gain deduction, as returns are over Rs 1 lakh, you’ll be left with Rs 1,80,490. The investment in the same will provide you with tax exemption, making Bharat Bond ETF less appealing to investors from higher tax brackets.

And after the 10% long-term capital gain deduction, as returns are over Rs 1 lakh, you’ll be left with Rs 1,80,490. The investment in the same will provide you with tax exemption, making Bharat Bond ETF less appealing to investors from higher tax brackets.

Total Capital Gain
InvestmentAmount in PortfolioGrowth RateCapital GainTotal Capial Gain
Initial Investment 202410000020.13%20130
202512013020.13%2418220130
202614431220.13%2905044312
202717336220.13%3489873362
202820826020.13%41923108260
202925018320.13%50362150183
2030300545200545

The lack of investors’ interest is evident in the numbers. Debt funds make less than 35% of total equity investments, while debt funds are less risky than other options. Hence, the Department of Investment and Public Asset Management (DIPAM) will send a formal recommendation regarding the Bharat Bond ETF to the Department of Revenue after the government is formed.

The government is considering a special carve-out for the Bharat Bond ETF from the prevailing tax structure. This could mean reverting to the earlier tax regime or introducing a new, more favorable tax rate for this specific ETF.

Impact on Fundraising

The Bharat Bond ETF has been instrumental in fundraising for CPSEs, CPSUs, CPFIs, and other government organizations. With over ₹33,400 crore raised through bond issuances, any tax relief could further bolster this instrument’s appeal.

A favorable tax change could increase the fund size, as more investors might be attracted to the tax-efficient nature of the ETF. It, in turn, could lower borrowing costs for the entities involved and lead to more efficient capital allocation.

Conclusion

The proposed changes to the capital gains tax for debt mutual funds, particularly the Bharat Bond ETF, could have far-reaching effects on the investment landscape. By providing tax relief, the government aims to make these instruments more attractive to investors, thereby cost-effectively supporting its borrowing needs. As we await the final decision, investors and fund managers keenly observe the developments, ready to recalibrate their strategies based on the outcome.

FAQs

  1. What is the Bharat Bond ETF?

    The Bharat Bond ETF is an Exchange-Traded Fund launched by the Indian government in 2018. It allows investors to invest in the debt of public sector companies. It is listed on the National Stock Exchange (NSE) and offers features like fixed maturity, liquidity, low cost, safety, predictability, and tax efficiency.

  2. How has the Finance Bill 2023 affected the Bharat Bond ETF? 

    The Finance Bill 2023 has placed the Bharat Bond ETF under the same tax bracket as other debt mutual funds, where the investor’s income tax slab determines the tax rate. This has removed the previous long-term capital gains tax advantage of 20% with indexation benefits for holdings over 36 months.

  3. What are the potential changes to debt mutual funds' capital gains tax structure? 

    The government is considering a special carve-out for the Bharat Bond ETF from the prevailing tax structure, which could involve reverting to the earlier tax regime or introducing a new, more favorable tax rate for this specific ETF.

  4. How does the tax efficiency of Bharat Bond ETF compare to other investment options like ELSS?

    The Bharat Bond ETF offers the benefit of indexation, which can significantly reduce the tax on long-term capital gains. However, higher tax slabs may make other investment options like Equity-Linked Savings Schemes (ELSS) more attractive due to their higher growth rates and tax exemptions.

  5. How could the proposed tax changes impact fundraising through the Bharat Bond ETF? 

    Any tax relief for the Bharat Bond ETF could increase its appeal to investors, potentially increasing the fund size. This could lower borrowing costs for public sector entities and lead to more efficient capital allocation.

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I’m Archana R. Chettiar, an experienced content creator with
an affinity for writing on personal finance and other financial content. I
love to write on equity investing, retirement, managing money, and more.

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