Income Plus Arbitrage Active FoFs: A Smarter, Tax-Efficient Alternative to Fixed Deposits

In investing, the headline return often gets all the attention.

But is that what truly matters? Or is it the return that finally lands in your bank account after tax?

Post the 2023 Union Budget, this distinction has become especially important for conservative investors.

With traditional debt mutual funds losing indexation benefits and concessional tax treatment, many high-income investors are left asking: Is there still a tax-efficient way to earn stable returns without taking equity-level risk?

One emerging answer lies in a relatively new category—Income Plus Arbitrage Active Fund of Funds (FoFs).

These funds aim to deliver debt-like stability with equity-style taxation, creating a compelling post-tax proposition when used correctly.

Let’s break this down in simple terms.

Table of Contents:

1. Why Tax Efficiency Can No Longer Be Ignored?
2. Debt Investments After the 2023 Budget: What Changed?
3. What Is an Income Plus Arbitrage Active FoF?
4. How the Arbitrage Strategy Actually Works?
5. Asset Allocation Structure and Equity Tax Status
6. Why This Category Stands Apart from FDs and Debt Funds?
7. Taxation Explained
8. FD vs Income Plus Arbitrage FoF: A Realistic Illustration
9. Who Should Consider This Category?
10. How to Use Income Plus Arbitrage FoFs in a Portfolio?
11. Risks and Limitations to Be Aware of:
12. Final Thoughts

Why Tax Efficiency Can No Longer Be Ignored?

Most investors evaluate an investment on three familiar parameters:

• Returns – What do I earn?
• Liquidity – Can I access my money easily?
• Risk – How volatile or unsafe is it?

But there’s a fourth factor that often gets overlooked—taxation.

Why does this matter?

Because a product offering a 7% pre-tax return may quietly deliver only 4.5–5% post-tax for someone in the 30% slab.

Over time, that difference compounds dramatically.

This blind spot is particularly common among conservative investors who default to fixed deposits or traditional debt products without fully accounting for the tax drag.

Debt Investments After the 2023 Budget: What Changed?

Before 2023, debt mutual funds enjoyed two big advantages:

• Indexation benefits
• Lower long-term capital gains tax

The 2023 Union Budget fundamentally altered this landscape:

• Capital gains from most debt mutual funds are now taxed at the investor’s income tax slab rate, irrespective of the holding period.
• For investors in the 30% slab, this sharply reduces post-tax returns.

That said, debt mutual funds still offer one advantage that fixed deposits do not—tax deferment.

Tax is payable only at the time of redemption, not annually.

Unfortunately, this benefit is often underestimated.

Income Plus Arbitrage Active FoFs build on this deferment advantage and go a step further by qualifying for equity taxation.

What Is an Income Plus Arbitrage Active FoF?

An Income Plus Arbitrage Active Fund of Funds is an open-ended mutual fund that invests in:

• Debt-oriented mutual funds for income and stability, and
• Arbitrage mutual funds to maintain equity exposure without taking directional market risk.

On the surface, the portfolio behaves like a conservative debt strategy.

But structurally, the arbitrage allocation allows the fund to qualify for equity taxation, which is the real differentiator.

Is this equity in the traditional sense? Not really—and that’s the point.

How the Arbitrage Strategy Actually Works?

Arbitrage funds aim to capture price differences between:

• The cash market, and
• The futures market of the same stock.

The strategy involves:

• Buying a stock in the cash market, and
• Simultaneously selling it in the futures market.

The price difference is locked in and realised at expiry.

Since there’s no market direction bet involved, volatility remains low.

Over time, arbitrage returns tend to resemble money-market or short-term debt yields, rather than equity returns.

So while the taxation is equity-like, the risk behaviour is not.

Asset Allocation Structure and Equity Tax Status

Typically, Income Plus Arbitrage Active FoFs:

• Allocate less than 65% to pure debt-oriented funds, and
• Allocate the balance to arbitrage strategies that qualify as equity exposure.

Because of this structure, investments held for more than 24 months qualify as long-term capital assets, and the gains are taxed as:

• Long-Term Capital Gains (LTCG): 12.5% (plus applicable cess and surcharge).

This single structural feature makes a meaningful difference to post-tax outcomes for high-income investors.

Why This Category Stands Apart from FDs and Debt Funds?

Aspect	Fixed Deposits	Debt Mutual Funds (Post-2023)	Income Plus Arbitrage Active FoF
Tax Rate	Slab rate	Slab rate	12.5% LTCG (after 24 months)
Tax Timing	Annual (accrual basis)	On redemption	On redemption
Return Visibility	Predictable	Market-linked	Market-linked but low volatility
Tax Efficiency	Low	Moderate (deferment only)	High

When taxation is factored in, the difference becomes difficult to ignore.

Taxation Explained

Income Plus Arbitrage Active FoF

• Holding Period: More than 24 months
• Tax Treatment: Long-term capital gains
• Tax Rate: 12.5% + cess/surcharge)
• Short-Term Gains: If redeemed before 24 months, taxed at slab rate

Fixed Deposits

• Interest is taxed at the investor’s income tax slab rate.
• Tax is payable every year on an accrual basis, even for cumulative FDs where interest is received only at maturity.

The combination of lower tax rate and tax deferment significantly enhances compounding.

FD vs Income Plus Arbitrage FoF: A Realistic Illustration

Scenario:

• Investment Amount: ₹10,00,000
• Time Horizon: 3 years
• Tax Slab: 30%

Fixed Deposit

• Interest Rate: 6.3%
• Annual Interest: ₹63,000
• Annual Tax: ₹18,900
• Total Tax Over 3 Years: ₹56,700
• Post-Tax Return: ~4.6%

Income Plus Arbitrage Active FoF (Illustrative – HDFC Income Plus Arbitrage FoF Direct Growth)

• Investment: ₹10,00,000 (Jan 2023)
• Value after 3 years: ₹14.26 lakh (Dec 2025)
• Long-Term Capital Gain: ₹4.26 lakh
• Tax @ 12.5%: ₹53,308
• Post-Tax Return: ~11.1%

Investment Avenue	Pre-Tax Return	Post-Tax Return
Fixed Deposit	6.3%	4.6%
Income Plus Arbitrage Active FoF	12.57%	11.1%

This comparison highlights how taxation can materially alter real returns.

Who Should Consider This Category?

Income Plus Arbitrage Active FoFs are suitable for:

• Investors in higher tax brackets (30% slab)
• Those with a minimum 2–3-year investment horizon
• Investors seeking low volatility and tax efficiency, not aggressive growth

This is not a product for return chasing. It is designed for boring money managed intelligently.

How to Use Income Plus Arbitrage FoFs in a Portfolio?

• As an alternative to bank fixed deposits for surplus funds
• As a tax-efficient parking option for short-to-medium-term goals
• As a stabilising allocation alongside equity-heavy portfolios

Allocation should remain measured and aligned with overall asset allocation.

Risks and Limitations to Be Aware of:

While attractive, investors must remember:

• These are relatively new offerings with limited track records
• Returns depend on fund structure, expense ratios, and execution
• They are not capital-guaranteed products

Used improperly or over-allocated, they can disappoint expectations.

Final Thoughts

Income Plus Arbitrage Active FoFs fill an important gap created by post-2023 tax changes.

They offer:

• Debt-like risk characteristics
• Equity-style taxation
• Significantly better post-tax outcomes for high-income investors

They are not a shortcut to higher returns—but when used judiciously, they can be a powerful tax-efficient tool within a diversified portfolio.

Given the structural complexity and tax nuances involved, guidance from a Certified Financial Planner (CFP) can help ensure these funds are used correctly and aligned with long-term financial goals.