Amendment to Finance Bill 2023 scrapped the indexation benefit on debt mutual funds. They will now be taxed at investor’s slab rates. These changes will bring the taxation of specified mutual funds at par with fixed deposits. Read on to know how this move may impact you and everything about the taxation of debt mutual funds.
Before discussing the changes, it is important to understand debt mutual funds and their current tax framework. Debt mutual funds are investment instruments which predominantly invest their funds in fixed-income securities like bonds, treasury bills, commercial papers, debentures, and other debt instruments. These securities usually generate returns in the form of interest or capital appreciation, which makes them a preferred investment choice for conservative investors.
For taxation purposes, a specified mutual fund invests more than 65% of its proceeds in debt and money market instruments.
The Budget 2023 has brought about certain amendments that imply that any gains arising from a transfer of units of Specified Mutual Funds bought on or after 1st April 2023 will be deemed as short-term capital gains irrespective of their holding period. Therefore, debt mutual funds will now be taxed at slab rates.
Indexation benefits will also not be available now as such funds can no longer be classified as long-term capital assets.
However, if the investment in such specified mutual funds was made before 1st April 2023, then the concept of Long-term capital gains will still be applicable. In such a case, to qualify as a long-term asset the investor should have held the units for more than 24 months from the date of acquisition. The gains will be taxed at 12.5% and indexation will not be available.
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. |
Earlier, the taxation of debt mutual funds was governed by the holding period rule:
Let us consider the tax flow on debt funds before and after the amendments.
Example 1: Mr X invested Rs. 10,00,000 in FY 2020-21 in a debt mutual fund and sold the investments after three years of holding them in FY 2023-24 for a sale value of Rs. 20,00,000, thereby earning a capital appreciation value of Rs. 10,00,000.
Particulars | Financial Year | Cost Inflation Index (CII) | Amount (Rs.) |
Investment Made | 2020-21 | 301 | 10,00,000 |
Sale | 2023-24 | 348 | 20,00,000 |
Less: Indexed Cost of Investment | (10,00,000*348/301) | (11,56,146) | |
Long-term capital gain | (20,00,000-11,56,146) | 8,43,854 | |
Tax Payable | Tax @ 20% | 1,68,770 |
Tax Liability in the same scenario but after the changes (from Financial Year 2023-24)
Particulars | Financial Year | Cost Inflation Index (CII) | Amount (Rs.) |
Sale | 2026-27 | - | 20,00,000 |
Less: Investment Made | 2023-24 | - | (10,00,000) |
Long-term capital gain | - | 10,00,000 | |
Tax Payable | Rs. 10,00,000 @ 12.5% | Rs. 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 | |
Upto 4 lakhs | 0 |
4 lakhs to 8 lakhs | 20,000 |
8 lakhs to 10 lakhs | 20,000 |
Short Term Capital Gains Tax | 40,000 |
Particulars | Fixed Deposits | Equity Mutual Funds (Equity: > 65% Debt: < 35%) | Debt Mutual Funds (Equity: <35% Debt: > 65%) | |
Old rule | New Rule | |||
Types of funds | FDs |
|
| |
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 | - |
Taxed at what rate? | At slab rates | - STCG: Slab rates - LTCG: 10% (on gains more than Rs 1 lakh) | - STCG: Slab rate - LTCG: 20% (with indexation benefit) | - Deemed to be STCG: Slab rate |
Set off and Carry Forward of Losses | Not Allowed | Allowed | Allowed | Allowed |
Despite the recent developments that suggest debt funds are now comparable to fixed deposits, there are still several compelling reasons why debt funds can be a great tax-saving investment option:
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