Taxation On Debt Mutual Funds
Debt Mutual Funds bought on or after 01st April, 2023 are now taxed at investor’s slab rates. While debt mutual funds are taxed on their sale, fixed deposits are not taxed on their redemption. Debt Mutual Funds provide a slightly higher returns as compared to fixed deposits. This article explains in detail, the taxation of debt mutual funds.
What are Debt Mutual Funds?
- 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.
Taxation Of Debt Mutual Funds After 1 April 2023
- 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. |
Taxation Of Debt Mutual Funds Before 1 April 2023
Earlier, the taxation of debt mutual funds was governed by the holding period rule:
- Short-Term Capital Gains: If the debt mutual fund unit is sold within 36 months (three years) of purchase, the gains are termed short-term capital gains (STCG). These STCGs were taxed at slab rates.
- Long-Term Capital Gain: However, if they were sold after 36 months, then the gains were termed long-term capital gains (LTCG). These long-term capital gains were taxed at 20% with an indexation benefit. Indexation benefit means the gains made by investors were adjusted for inflation. This is illustrated in the table below.
How Will The Changes In Income Tax Rules Affect Taxation On Debt Mutual Funds?
Let us consider the tax flow on debt funds before and after the amendments.
Illustration for Tax Treatment before Amendment
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 |
Illustration for Tax Treatment after Amendment
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.
Comparison Of Fixed Deposits And Mutual Funds Taxation
| 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 | - |
| Taxed at what rate? | At slab rates | 1. STCG: Slab rates 2. LTCG: 10% (on gains more than Rs 1 lakh) | 1. STCG: Slab rate 2. LTCG: 20% (with indexation benefit) | - Deemed to be STCG: Slab rate |
| Set off and Carry Forward of Losses | Not Allowed | Allowed | Allowed | Allowed |
Are Fixed Deposits(FDs) Better Than Debt Mutual Funds?
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:
- Flexi FDs offer the flexibility to withdraw funds without penalty. However, if you opt for regular FDs, you may have to pay the penalty for early withdrawal. Conversely, debt funds impose no exit loads after a certain period. Therefore, debt funds provide greater liquidity and can be more cost-effective than Bank FDs.
- Debt funds typically yield higher returns than fixed deposits.
- Profits from Debt mutual funds are classified as capital gains, while fixed deposits are categorised as ‘income from other sources’. This means that in the event of losses with debt mutual funds, they can be carried forward and offset against gains.
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About the Author
CA Mohammed S Chokhawala
I'm a chartered accountant, well-versed in the ins and outs of income tax, GST, and keeping the books balanced. Numbers are my thing, I can sift through financial statements and tax codes with the best of them. But there's another side to me – a side that thrives on words, not figures. Read more
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