Income Tax on Redemption of Debt Mutual Funds

The taxation of debt mutual funds has undergone multiple changes, with amendments effective from April 1, 2023. Debt mutual funds purchased on or after this date are taxed at the applicable income slab rate, regardless of the holding period, and may qualify for a rebate under Section 87A. Investments made before April 1, 2023, and redeemed before July 23, 2024, were previously taxed at 20% with indexation if held for over 36 months. However, redemptions on or after July 23, 2024, will be taxed at 12.5% without indexation, with the required holding period reduced to 24 months. Capital gains from short-term holdings continue to be taxed at the slab rate. Taxpayers should verify their purchase and redemption dates to determine the applicable tax treatment.

1. Debt mutual funds are investment instruments that predominantly invest their funds in debt and money market instruments. This includes Liquid Funds, Corporate Debt Funds, Credit Risk Funds, Gilt Funds and Conservative Hybrid Funds, among others. For taxation purposes , Debt Mutual Funds are schemes investing a minimum of 65% of their assets in debt money market instruments.

2. Debt mutual funds are taxed differently based on date of purchase. There have been frequent amendments in the Capital Gain taxability of Debt Mutual Funds effective from 01.04.2023. Taxpayers are really confused and finding it difficult to ascertain their tax liability on redemption of Debt Mutual Funds.

3. In this article, an attempt has been made to simplify the computation of tax on sale of Debt Mutual Fund units.

4. Debt Mutual Funds purchased on or after 1^st April 2023 qualify for a Rebate u/s 87A Budget 2025 introduces tax benefits for debt mutual fund investors based on purchase date. The thumb rule for tax rebate under section 87A is that whatever is taxed at slab rate is eligible for tax rebate under this section. Capital gains tax on Debt Mutual Funds purchased on or after 1^st April 2023 is taxable at slab rate, irrespective of holding period. Let us try to understand it with the help of an illustration .

Illustration : Mr. Anuj purchased Debt MF in June 2023. He sold the units in April 2025 and made a capital Gain of Rs. 12,00,000 . Assuming that he has no other income in FY 2025-26 , the tax liability will be calculated at slab rate and he will be qualified for a rebate of Rs. 60000/- under section 87A . The net Tax liability will be NIL.

Mr. Anuj is advised to delay selling debt mutual funds after 01.04.2025 in order to reduce tax liability. In case , he chooses to sell the units before 1^st April 2025 , the amount of tax rebate will be Rs. 25,000/-( as per slab applicable in FY 2024-25).

5. Debt mutual fund purchases made before April 2023: The txation of debt mutual funds was changed with effect from April 1, 2023. The indexation benefit in calculation of tax on long term capital gains was removed for debt mutual funds. Due to this, capital gains arising from the sale of debt mutual funds became taxable at the income tax slab rate applicable to the recipient’s income. Hence, from April 1, 2023, capital gains from debt mutual funds are no longer divided as short-term and long-term capital gains.

However, the long- term capital gains tax on investments in debt mutual funds made before 01 April 2023 was still taxed at 20% with indexation benefit. The holding period was 36 months for considering these as long -term capital assets . Thus, Debt Mutual Fund units that were purchased before 01 April 2023 , held for more than 36 months and redeemed before 23.07.2024 were subject to tax @ 20% with indexation benefit

Illustration : Mr. Anupam invested Rs 1 lakh in Debt Mutual Fund in 2019-20 and sold the investment after three years of holding them in 2023-24 for Rs. 6 lakhs. The capital gains Tax computation is as follows

(Sale price – Indexed cost of acquisition) * 20%

(6,00,000- (1,00,000* 348/289)) * 20%

(6,00,000- 1,20,415 )* 20%

Rs, 95,917/-

6. Debt mutual fund purchased before April 2023 and redeemed on or after 23.07.2024 : The Union Budget for FY 2024-25 announced on July 22, 2024, made significant changes to the capital gains tax structure related to various asset classes. The Government rationalized the capital gains taxation regime for all assets. LTCG from selling an asset (listed or unlisted securities) is taxable at 12.5% without indexation benefit.

However, capital gains on debt mutual funds ( purchased after 01.04.2023 )continue to be taxed at the slab rate applicable to the recipient’s income instead of the new LTCG tax rate of 12.5%.

Capital gains from the debt mutual funds purchased before 01.04.2023 that were previously taxed as long-term capital gains at 20% with indexation, will be taxed at 12.5% without indexation. if the units are redeemed on or after July 23, 2024. Furthermore, the holding period to categorize the capital gains as long-term will be reduced to 24 months.

Illustration: Ms. Beena invested in Debt Mutual Fund in March 2022 and planning to redeem the units in April 2025. Assuming that her capital gain from such redemption will be Rs. 12,00,000. After considering basic exemption limit of Rs. 4,00,000/- the Capital gains tax will be 12.5% on Rs 8,00,000 = Rs. 1,00,000.

In the above illustration, Ms. Beena held Debt Mutual Fund units for more than 24 months and redeemed it after 23 July 2024. The units were purchased before 01.04.2023. It shall be taxed @ 12.5% without indexation.

In case, she chooses to redeem the said units before 01.04.2025, the basic exemption limit for FY 2024-25 was Rs 3,00,000 and her tax liability works out as (9,00,000 * 12.5% ) = Rs. 1,12,500/-.

7. The above provisions can be summarized as follows :

8. Income tax on Debt Mutual Funds may differ from case to case based on the returns earned as well as the year of purchase. Hence, taxpayers should check the transaction date of purchase of debt mutual funds to understand the tax implications.

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Disclaimer : The article is for educational purposes only.

The author can be approached at caanitabhadra@gmail.com