The taxation of debt mutual funds depends on the date of purchase and their holding period. For units purchased on or after 1st April 2023, any gains from transfer, redemption, or maturity are treated as short-term capital gains and taxed at the investor's applicable slab rate, irrespective of the holding period.
However, for units purchased before 1st April 2023, the tax treatment varies based on how long they are held. If held for more than 2 years, the gains are taxed as long-term capital gains at a flat rate of 12.5% without indexation benefits. If held for 2 years or less, they are taxed as short-term capital gains at the investor's slab rate.
Debt mutual funds are investment instruments that primarily invest in fixed-income securities such as bonds, treasury bills, commercial papers, debentures, and other debt instruments. These funds generate returns mainly through interest income and occasional capital appreciation, making them an attractive option for conservative investors seeking stable and predictable returns with lower risk compared to equity funds. For taxation purposes, a mutual fund is classified as a debt mutual fund if it invests more than 65% of its total proceeds in debt and money market instruments.
From 1st April 2023, the taxation of debt mutual funds has changed significantly due to amendments in Budget 2023. Any gains arising from the transfer, redemption, or maturity of units of debt mutual funds purchased on or after this date will be treated as short-term capital gains, regardless of the holding period. These gains will be taxed at the investor’s applicable slab rates, and the benefit of indexation will no longer be available, as such funds are no longer classified as long-term capital assets.
However, if the investment was made before 1st April 2023, the earlier rules will continue to apply. In such cases, if the units are held for more than 24 months, the gains will be considered long-term capital gains and taxed at 12.5% without indexation benefits. If held for 24 months or less, they will be taxed as short-term capital gains at the applicable slab rate.
This can be summarised as follows:
Purchase Date | Tax Implication |
Before 1st April 2023 | LTCG at 12.5% after holding for more than 2 years. Else STCG at slab rates. |
On or After 1st April 2023 | Gains are taxed at applicable slab rates. |
Before 1st April 2023, the taxation of debt mutual funds was based on their holding period. If a debt mutual fund unit was sold within 36 months (three years) of purchase, the gains were classified as short-term capital gains (STCG) and taxed at the investor’s applicable slab rates. However, if the units were sold after 36 months, the gains were treated as long-term capital gains (LTCG) and taxed at 20% with the benefit of indexation. The indexation benefit allowed investors to adjust their purchase cost for inflation, effectively reducing their taxable gains and the overall tax liability.
Let us consider the tax flow on debt funds before and after the amendments.
Example 1: Mr X invested Rs. 10 lakhs in FY 2020-21 in a debt mutual fund and sold the investments after four years of holding them in FY 2024-25 on or after 23rd July, 2024 for a sale value of Rs. 20 lakhs, thereby earning a capital appreciation value of Rs. 10 lakhs.
Particulars | Financial Year | Amount (Rs.) |
Investment Made | 2020-21 | 10,00,000 |
Sale | 2024-25 | 20,00,000 |
Less: Cost of Investment | (10,00,000) | 10,00,000 |
Long-term capital gain | (20,00,000-10,00,000) | 10,00,000 |
Tax Payable | Tax @ 12.5% | 1,25,000 |
Example 2: Mr. X invested Rs. 20,00,000 in a debt mutual fund in FY 2024-25. He sold the units in FY 2025-26 for Rs. 30,00,000. In this scenario, as the investment was made after 1st April 2023 the gains will be deemed as short-term capital gains irrespective of the holding period. The computation will be as follows:
Assuming that Mr. X opts for the New Tax Regime
Particulars | Amount |
Sale Consideration | 30,00,000 |
(-) Cost of Acquisition | -20,00,000 |
Short Term Capital Gains | 10,00,000 |
Tax Liability | |
Up to 4 lakhs | 0 |
4 lakhs to 8 lakhs | 20,000 |
8 lakhs to 10 lakhs | 20,000 |
Short Term Capital Gains Tax* | 41,600 |
*The above calculation is based on the assumption that there is no other income for the assessee during the financial year.
Particulars | Fixed Deposits | Equity Mutual Funds (Equity: ≥ 65% Debt: < 35%) | Debt Mutual Funds (Equity: <35% Debt: ≥ 65%) | |
Types of funds | FDs | Equity funds Aggressive hybrid fund Balanced advantage funds Arbitrage funds | All debt funds Gold ETF Multi-asset funds Conservative hybrid fund International FoF | NA |
Interest Rates (or) Returns | 6-8% | 10-12% | 7-9% | NA |
Risk Factor | No Risk | Moderate to High Risk | Low to moderate risk | NA |
Liquidity | Minimal Liquidity | Highly liquid (subject to exit load) | Highly liquid (subject to exit load) | NA |
Investment Option | One Time Investment | One Time Investment or SIP options available | One Time Investment or SIP options available | NA |
Related Expenses | No such expenses | Nominal amount is charged as expense ratio. | Nominal amount is charged as expense ratio. | |
Tax Implications | Old rule | New Rule | ||
What is Taxable? | Interest | Capital Appreciation | Capital Appreciation | Capital Appreciation |
When is it Taxable? | Every Year on an accrual basis | Whenever you sell (redeem) the mutual fund units | Whenever you sell (redeem) the mutual fund units | Whenever you sell (redeem) the mutual fund units |
Holding Period | - | 12 months | 24 months | Holding Period Not Applicable |
Taxed at what rate? | At slab rates | Transfer Before 23 July 2024 - STCG: 15% rates - LTCG: 10% (on gains more than Rs 1.25 lakh) Transfer On or After 23 July 2024 - STCG: 20% rates - LTCG: 12.5% (on gains more than Rs 1.25 lakh) | Purchased Before 1 April 2023 - STCG: Slab rate - LTCG: 12.5% (without indexation benefit) | Purchased On or After 1 April 2023 - Deemed to be STCG: Slab rate, irrespective of holding period. |
Set off and Carry Forward of Losses | Not Allowed | Allowed | Allowed | Allowed |
While recent tax changes have made debt mutual funds similar to fixed deposits in terms of taxation, debt mutual funds still offer several advantages over FDs. Unlike regular FDs, which often impose penalties on premature withdrawals, debt mutual funds generally have no exit load after a certain period, making them more liquid and cost-effective. Additionally, debt mutual funds tend to provide higher returns compared to fixed deposits. Another benefit is in their taxation:
These factors make debt mutual funds a potentially better option for tax efficiency and returns compared to traditional FDs.
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