How income plus arbitrage FoFs are more tax-efficient than debt funds: The impact on investor returns

Income Plus Arbitrage Fund of Funds (FoFs) combine debt-oriented and arbitrage funds within a single mutual fund structure. These FoFs use rule-based strategies for the underlying investments, while the arbitrage fund component seeks to capture price differences between the cash and futures markets.

This structure can also create a difference in taxation compared with traditional debt funds, particularly for investors in higher tax brackets holding the investment for more than 24 months.

What are Income Plus Arbitrage FoFs?

Income Plus Arbitrage FoFs invest in a combination of debt-oriented schemes and arbitrage-based schemes. As per the Securities and Exchange Board of India (Sebi) circular dated 26 February 2026, these FoFs can invest up to 65% in underlying debt-oriented schemes, with the balance invested only in arbitrage-based schemes.

The debt portion is intended to provide relatively stable returns through fixed-income strategies, while arbitrage funds seek to benefit from price differences between a security in the cash market and its corresponding futures position. This can provide greater transparency around the investment approach.

How Income Plus Arbitrage FoFs are more tax efficient?

The tax advantage of an Income Plus Arbitrage FoF lies in how they are classified for tax purposes. Since the FoF invests less than 65% in debt-oriented schemes and allocates the remaining portion to arbitrage schemes, its taxation differs from that of a debt fund.

If held for up to 24 months, capital gains from the FoF are taxed at the investor’s applicable income tax slab rate. For investments held for more than 24 months, the gains qualify as long-term capital gains and are taxed at 12.5%, without indexation.

However, gains from debt-oriented mutual funds are taxed at the investor’s applicable slab rate irrespective of the holding period.

This difference can be particularly relevant for investors in the 30% tax slab. Consider a ₹1 lakh investment in both options, assuming an annual return of 7% over a two-year period.

Source: Quant Mutual Fund NFO Presentation. As per the Finance Act, 2023; excludes cess and surcharge.

Despite generating the same pre-tax return of 7%, the Income Plus Arbitrage FoF offers a higher post-tax return than the debt fund, as the long-term capital gains are taxed at 12.5% compared with the investor’s 30% slab rate.

However, the actual impact may vary depending on the scheme’s returns, holding period, and the individual’s tax circumstances.

Disclaimer: This is purely for educational/informational purposes and should not be taken as any sort of investment advice. Always consult a SEBI-registered advisor before making any investment decisions.