(Bloomberg) -- India’s parliament removed a tax concession for debt funds, stirring concern in the mutual fund industry that the measure would turn away investors.

Holders of some bond funds will no longer be able to apply a long-term capital gains tax rate, according to a finance bill amendment approved Friday. Instead, they’ll have to pay based on their own income tax rate, implying the levy could be as high as 30%.

The Finance Ministry defended the amendment, saying the decision removes arbitrage. “Many taxpayers are able to reduce their tax liability through this arbitrage,” the ministry said in statement. “This is sought to be addressed.”

While fixed-income mutual funds hold just about 3% of India’s outstanding sovereign debt, according to central bank data, much of this was money from ultra-rich investors and family offices who used the instrument to save taxes. These investors could now seek to park their cash elsewhere.

“Debt mutual funds will lose that beneficial tax regime and be treated at par with fixed deposits,” said Amit Maheshwari, a partner at AKM Global. “This proposed move will hit high net worth individuals who were using this investment as tax saving instruments.”

Funds Fret Over India Tax Proposals Impacting $150 Billion Debt

Fund managers on Friday took to social media to express concerns that the move will hurt the nation’s $150 billion mutual fund debt market. Shares of asset managers such as Aditya Birla Sun Life AMC and HDFC AMC declined.

“As most of these funds have a higher allocation to AAA corporate debts, moderation in flows is expected to lead to widening of corporate spreads,” said Abhishek Bahinipati, fixed-income trading head at Mirae Asset Capital Markets Ltd. “Growing issuances with falling demand can cause a spreads to widen by 10-15 basis points.”

Top-rated bonds issued by non-bank finance companies and mortgagers, with maturities of 3-5 years that are trading at a spread of 20-25 basis points over similar debt from state-owned companies are likely to be worst hit, according to Bahinipati. 

Yield on top-rated three-year corporate bonds rose by as much as 5 basis points at opening, but pared gains as global factors such as a drop in US Treasury yields and lower oil prices took centre stage, traders said. Market players don’t see an immediate impact of the tax move on yields this month as the change will be effective in April. 


--With assistance from Vrishti Beniwal, Abhijit Roy Chowdhury, Chiranjivi Chakraborty, Adrija Chatterjee, Akshay Chinchalkar, Abhay Singh, Ronojoy Mazumdar and Divya Patil.

(Updates throughout)

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