Taxation of Debt Mutual Funds – Here is All You Need to Know

In the last one year, debt mutual funds in India across categories turned attractive and delivered high single-digit returns which can be attributed to the expectation of a rate cut by the RBI in the near future as well as strong inflows by foreign institutional investors into Indian government bonds. It is expected that debt funds may gain further when RBI starts the rate cut cycle.

But how are gains on debt mutual funds taxed?

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. as per the government’s rationalisation of the capital gains tax regime for all assets announced in the Union Budget, from July 23, 2024, long term capital gains from selling an asset are taxable at 12.5% without indexation benefit. These changes impact capital gains earned on mutual funds as well.

Watch this video to know about the changes in mutual fund taxation post the Union Budget 2024:

In the case of gains on debt mutual funds there has been no change in tax rates. Notably, the government had amended the Finance Bill in 2023 under which it removed the indexation benefit for debt mutual funds which was applicable on long-term holdings (more than 3 years) to make it on par with Bank FDs. Accordingly, with effect from April 01, 2023, capital gains arising from the sale of debt mutual funds are now taxable as per the marginal rate (i.e. as per the income tax slab rate applicable to the investor’s income), regardless of the holding period.

However, long term capital gains tax on investments in debt mutual funds made on or before March 31, 2023, were still taxed at 20% with indexation benefit. So what will be the tax treatment for debt mutual funds purchased before April 01, 2023?

Do note that capital gains from the debt mutual fund bought on or before March 31, 2023, which were previously taxed as long-term capital gains at 20% with indexation, will now be taxed at 12.5% without indexation if the units were redeemed on or after July 23, 2024. Further, the holding period to categorise the capital gains as long-term has been reduced to 24 months from 36 months earlier.

Conclusion

The change in long term capital gains tax rules for debt mutual funds will retrospectively impact investors who invested to avail of the indexation benefit. Moreover, the change in tax structure from 20% with indexation to 12.5% without indexation may result in higher tax liability as indexation helped investors adjusted the purchase price, which has been now done away with.

However, the impact 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 fund to understand the tax implication.

When investing in debt mutual funds, remember that they are not risk free as they may be vulnerable to various risks such as liquidity risk, credit risk, default risk, etc. Additionally, debt mutual funds may not always generate higher returns compared to Bank FDs. Hence, investors must evaluate their options and select the most suitable debt mutual fund scheme from various durations and credit profiles.

[Read: 10-Year Government Bond Yield Has Spiked. Here’s Why]

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DIVYA GROVER is the co-editor for FundSelect, the flagship research service of PersonalFN. She is also the co-editor of DebtSelect. Divya is an avid reader which helps her in analysing industry trends and producing insightful articles for PersonalFN’s popular newsletter – Daily Wealth letter, read by over 1.5 lakh subscribers.

Divya joined PersonalFN in 2019 and has since then used stringent quantitative and qualitative parameters to analyse funds to provide honest and unbiased research to investors. She endeavours to enable investors to make an informed investment decision and thereby safeguard their wealth.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.