No More Interest Deduction on Mutual Funds and Dividends: What Budget 2026 Means for Investors
Understanding the Key Change in Union Budget 2026
Union Budget 2026 introduces a significant shift in taxation for investors by disallowing deductions for interest expenditure incurred to earn dividend income or income from mutual fund units, effective from April 1, 2026. Previously, taxpayers could claim up to 20% of gross dividend or mutual fund income as a deduction for such interest expenses. This amendment aligns with the government’s push for a simplified tax regime under the new Income-tax Act, 2025, aiming to broaden the tax base and increase revenue collection.
The change directly impacts investors who borrow funds to invest in shares, mutual funds, or dividend-paying assets. For instance, loans taken for purchasing mutual fund units or earning dividends will no longer offset taxable income through interest deductions, leading to a higher effective tax burden. This provision was highlighted in the Budget analysis by PRS India, confirming no such deductions shall be allowed moving forward.
Why This Change Matters
- Increased Tax Liability: Investors previously reducing taxable income by 20% via interest now face full taxation on earnings.
- Affects Loan-Financed Investments: Common strategy of leveraging debt for equity or fund investments becomes costlier.
- Part of Broader Reforms: Complements hikes in Securities Transaction Tax (STT) on derivatives and changes in MAT credits.
Implications for Mutual Fund and Share Investors
For mutual fund investors, this means dividend income and gains from units will be fully taxable without the interest offset, potentially discouraging leveraged investments. Equity mutual funds, spared from STT hikes unlike F&O, still face this deduction curb, which could alter portfolio strategies. The Budget did not raise the capital gains exemption limit from ₹1.25 lakhs to ₹2 lakhs as hoped by many, adding to investor concerns.
Share investors borrowing to buy stocks for dividends will see similar impacts. Combined with STT increases—from 0.1% to 0.15% on options and 0.02% to 0.05% on futures—transaction costs rise, squeezing returns. However, positive notes include potential inflows to gold mutual funds due to altered Sovereign Gold Bond (SGB) taxation: from April 1, 2026, capital gains exemptions on maturity apply only to RBI-direct purchases, pushing secondary market holders toward mutual funds or ETFs.
Sectoral Ripples
- Banking and NBFCs: Reduced demand for investment loans as tax arbitrage diminishes.
- Equity Funds: Shift toward unleveraged, long-term SIPs over borrowed investments.
- Gold Funds: Likely beneficiaries from SGB rule changes.
ClearTax notes sector winners like defence and infrastructure funds amid a ₹12.2 lakh crore capex push, but tax changes temper mutual fund enthusiasm.
What Investors Should Do Next: Strategies and Compliance
Investors must reassess leveraged portfolios before FY 2026-27. Switch to debt-free investing via SIPs in ELSS or index funds to optimize taxes. Review loan agreements for mutual fund or dividend investments and explore alternatives like direct equity without borrowing.
Compliance is key: File declarations under Section 393(6) for mutual fund income via depositories. Brought-forward MAT credits remain usable up to 25% of liability in the new regime, but no new accumulations post-April 1, 2026. MAT rate drops to 14%, offering minor relief to corporates.
Actionable Steps
- Portfolio Audit: Calculate pre- and post-change tax outgo; unwind high-interest loans if viable.
- Tax Planning: Maximize Section 80C via ELSS; consider new tax regime benefits.
- Monitor Updates: Track Income Tax Department FAQs for filing changes effective April 1, 2026.
- Professional Advice: Consult a Chartered Accountant for personalized impact assessment.
This Budget balances growth initiatives like manufacturing revival with fiscal prudence, but for retail investors, it signals a move away from debt-leveraged plays. With income tax collections projected to rise 11.7%, the onus is on taxpayers to adapt strategically. Stay informed, realign investments, and ensure compliance to navigate this evolving landscape effectively.