Will FM Sitharaman announce tax incentives for fixed-income instruments in Budget 2026?

Experts expect the Union Budget to focus on reducing the cost of capital and strengthening the corporate bond market through potential tax reforms

• Debt mutual funds taxed at slab rate, reducing their appeal for investors
• Experts call for tax reforms in Budget to boost corporate bonds and debt fund inflows.
• Restoring indexation benefits could make fixed income more attractive for savers

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While equity mutual funds continue to enjoy a favourable capital gains tax structure, debt mutual funds remain at a disadvantage, lowering investor interest. Long-term and short-term gains on debt funds no longer receive concessional tax treatment; redemption proceeds are taxed at the investor’s slab rate. This has reduced the appeal of debt products at a time when a more developed and efficient corporate bond market is needed to channel long-term savings into productive investments.

Experts expect the Union Budget to focus on reducing the cost of capital and strengthening the corporate bond market through potential tax reforms.

Currently, debt mutual funds are taxed at the investor’s marginal income tax rate, regardless of the holding period, following the removal of indexation benefits in 2023. This has made them less attractive compared to equity or direct bond investments.

“If the government targets a lower fiscal deficit than expected, it could push bond yields lower, increasing the NAV of existing debt or fixed income funds. The Association of Mutual Funds in India (AMFI) has proposed restoring Long-Term Capital Gains (LTCG) benefits for debt funds to reverse the decline in inflows,” said Sameer Mathur, MD and founder of Roinet Solution.

Market consensus also expects RBI to hold policy rates steady through 2026, anchoring short-rates and reducing volatility in short and medium-term debt instruments. Mathur said, “Short-duration and ultra-short funds may benefit from stable policy rates and RBI liquidity operations.”

From a budget perspective, experts have been pushing over the past few years to align fixed income with other asset classes and to support the development of collateral frameworks. However, fund flows have not significantly shifted toward traditional fixed income products, mainly because they remain tax-inefficient. As a result, investors are missing out on a crucial asset class.

“Tax clarity and incentives, if announced, will be a major positive driver for debt funds, potentially improving net yields after tax and catalysing inflows. Investors should look for opportunities in the corporate bond market as the government seeks to deepen this segment,” added Mathur.

Traditional fixed-income products, however, remain excluded. “Introducing indexation would significantly enhance the attractiveness of fixed income for average savers, particularly those within the Rs 12 lakh income bracket,” said Sachin Jain, Managing Partner, Scripbox.

Jain said ironically, retirees, despite relying heavily on fixed income due to pension income, are often forced into conservative hybrid products purely for tax efficiency, which may not always align with their risk profiles. “This highlights the need for policy correction. Additionally, the development of a robust listed bond market has been a long-pending reform that remains unaddressed,” he said.

Until market infrastructure develops further, mutual fund fixed income continues to be the most stable option for retail investors. Implementing indexation is thus a vital and timely reform to help restore stability and investor trust in the fixed income sector.