When the government launched the Bharat Bond ETF in December 2019, it was hailed as a revolutionary step towards democratising the bond market and offering retail investors a predictable and secure investment option. Budget 2024, however, has left these same investors reeling.
The removal of indexation benefits (a tax adjustment to account for inflation) on debt funds has drastically increased the tax burden on investors, slashing the post-tax returns they had come to expect.
This underscores the importance of understanding the tax implications on investment products, highlighting how policy shifts can significantly alter financial outcomes.
The Bharat Bond story began in early 2019 when the Department of Investment and Public Asset Management (DIPAM), a government agency managing all exchange-traded fund programs and overseeing public sector undertakings, initiated the concept.
The primary objective was to create an additional borrowing stream for PSUs, and to enable individuals to invest directly in such enterprises through an exchange-traded fund, or ETF.
The key objective was to establish a new borrowing stream for PSUs beyond traditional sources such as insurance companies, markets, and mutual funds. By attracting retail investors directly to PSUs through the ETF, the bonds would also benefit from secondary market trading, promising liquidity.
Additionally, the ETF aimed to offer PSUs a borrowing source with better yields than those available in the wholesale or primary markets, and to introduce more liquidity into the bond market by floating more bonds through ETFs.
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Assured predictability of returns
After DIPAM floated the tender for this debt ETF, Edelweiss emerged as the highest bidder, securing the mandate. Edelweiss spent 2019 creating a unique structure in the target maturity segment, providing predictability of returns and liquidity.
The product was designed as a target maturity ETF, which assured predictability of returns while being listed for easy buy-sell transactions. In December 2019, Edelweiss launched the first tranche, raising nearly ₹10,000 crore.
Subsequently, it launched ETFs with two maturities each year, leading to five maturities today, with one maturing in 2023.
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This initiative spurred other fund houses to follow suit, creating a category that now stands at about ₹1.7 trillion, making it the largest debt mutual fund category after liquid and overnight funds, with Edelweiss holding the highest market share.
However, in its Union budget for 2023-24, the government removed the benefit of indexation and 20% tax rate for debt mutual funds held for 3 years or longer. This killed the case for any further issues of Bharat Bond ETF.
However, it ‘grandfathered’ or protected the investments made in Bharat Bond ETFs and other debt funds before April 2023.
Budget 2024 (for 2024-25) went a step further. It removed the benefit of indexation for investments made after 1 April 2023, drastically affecting returns for investors.
A broken promise
Prior to the budget, long-term capital gains (LTCG) on investments held for over 3 years were taxed at 20% with the benefit of indexation. Post-budget, the tax regime shifted to a 12.5% tax rate on LTCG for investments held for over 2 years, without indexation. Short-term capital gains for investments held under 2 years will be taxed at the investor’s slab rate.
The impact of this tax change is starkly evident when comparing pre-budget and post-budget taxable gains and returns.
For instance, the April 2025 ETF, with a yield to maturity (YTM) of 7.5%, has an AUM of ₹11,872.42 crore. An investment of ₹10,00,000 in this ETF would yield ₹14,35,629 on maturity.
Under the pre-budget tax regime, the tax would have been ₹43,795.2, but post-budget, the tax increased to ₹52,275, a hike of 19%.
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Similarly, the April 2030 ETF, with a YTM of 7.35% and an AUM of ₹19,030 crore, would see an investment of ₹10,00,000 grow to ₹21,81,838 on maturity. The tax on gains pre-budget would have been ₹1,28,477, but post-budget, it rises to ₹1,41,821, a 10% increase.
The April 2031 ETF, with a YTM of 7.34% and an AUM of ₹13,981.21 crore, would see a tax hike from ₹1,28,030 to ₹1,41,552, an increase of 11%. For the April 2032 ETF, with a YTM of 7.32% and an AUM of ₹11,373.1 crore, the tax increases from ₹1,27,137 to ₹1,41,017, an 11% rise.
The April 2033 ETF, with a YTM of 7.31% and an AUM of ₹5,780.81 crore, would see its tax jump from ₹1,26,692 to ₹1,40,749, an 11% increase.
These substantial tax hikes have led to a significant decrease in the post-tax yield to maturity for Bharat Bond ETFs, making these less attractive to investors.
The removal of indexation has increased the tax burden on returns, reducing the net gains for investors and negating the initial investment promise of predictability and attractiveness.
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