What Are Income Plus Arbitrage FoFs? Fund Houses Launching Them & Taxation Rules You Should Know

Starting from April 1, 2025, a significant shift in the taxation framework for Fund of Funds (FoFs) will take effect. Under the new regime, gains from FoFs held for more than 24 months will now be considered long-term capital gains (LTCG) and taxed in line with equity-oriented investments at 12.5%.

This change brings some alignment between the taxation of equity and certain hybrid fund categories. However, short-term capital gains (STCG) — for investments held for less than 24 months — will continue to be taxed at the investor’s applicable income tax slab rate.

Comparison with Pure Debt Mutual Funds

In contrast to the revised FoF tax treatment, pure debt mutual funds continue to be taxed at the investor’s marginal income tax rate, irrespective of the holding period. This makes them relatively less tax-efficient in the long term, especially for investors in higher tax brackets.

Introduction of Income Plus Arbitrage FoFs

Recognising the potential in the new tax framework, several fund houses have launched a new category of schemes called Income Plus Arbitrage FoFs. Notably, Bandhan Mutual Fund, Kotak Mutual Fund, and UTI Mutual Fund have recently rolled out schemes under this segment.

These funds are designed to combine fixed income instruments with arbitrage opportunities in equities to offer a potentially stable return profile with limited volatility.

Read More: What is a Fund of Funds? Understand its Meaning, Types and Advantages

Key Features of Income Plus Arbitrage FoFs

Blended Investment Strategy

Income Plus Arbitrage FoFs typically invest in a mix of:

• Debt instruments such as bonds, treasury bills, and other money market instruments.

• Equity arbitrage mutual funds capitalise on price differences in equity securities across markets or timeframes.

Controlled Equity Exposure with Lower Volatility

The arbitrage component of the equity allocation ensures minimal volatility, making it a lower-risk approach to gain equity exposure.

Defined Asset Allocation Limits

To qualify for equity taxation:

• Arbitrage-based equity mutual fund allocation must be ≥ 35% at all times.

• Debt-based allocation must be ≤ 65% of the total assets.

Expense Cap

The Total Expense Ratio (TER) for this category is capped at 2%, keeping operational costs in check for investors.

Tax Efficiency and Investor Considerations

The newly introduced taxation regime appears to make Income Plus Arbitrage FoFs more tax-efficient than traditional pure debt funds over a longer holding period. However, these schemes are structured as FoFs, and hence the actual post-tax returns will depend on multiple factors, including the fund’s performance, cost structure, and the investor’s tax bracket for short-term gains.

Conclusion

The changing taxation landscape for Fund of Funds has opened avenues for more strategically structured offerings like Income Plus Arbitrage FoFs. By blending debt securities with arbitrage equity strategies, these funds aim to deliver stability with tax efficiency under the new framework, though investors should stay informed about underlying structures and implications.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. This does not constitute a personal recommendation/investment advice. It does not aim to influence any individual or entity to make investment decisions. Recipients should conduct their own research and assessments to form an independent opinion about investment decisions. 

Mutual Fund investments in the securities market are subject to market risks, read all the related documents carefully before investing.