Debt Mutual Fund Taxation – Uncovering Capital Gains Calculation & Indexation Benefit

Finally, you decide to invest in debt fund but now confused that how debt mutual fund taxation works?

I know investing is always an overwhelming subject due to availability of so many options around us and from that mutual fund investing is the most common one.

But yes, learning about taxation is as much important as investing so that you can properly manage the gains in such a way that you will end up having most of your wealth corpus in your bank instead of government one’s.

Hence, today I will explain what are debt funds, how they are taxed, capital gain on debt mutual fund, and much more.

So, let’s get started!

What are Debt Mutual Funds?

Debt Fund is a type of mutual fund where it pools the money from investors like us and invest in debt instruments like treasury bills, bonds, debentures, etc.

In simple terms we can understand debt mutual funds are a kind of mutual fund that gives the loan to different companies and government for which they get assured returns in exchange.

After the 2024 new budget, the debt mutual fund meaning has been changed a bit, now all the mutual funds which invest more than 65% of the money in debt instruments are considered and taxed as debt funds.

You can do a SIP in debt fund or can invest a lumpsum amount.

In India, still many people invest in Fixed Deposits, so debt fund are kind of fixed deposit only where you get 7-9% average annual returns.

Debt Mutual Fund Taxation

After the budget 2024 was announced debt fund taxation got changed completely.

Hence, now after the new budget of India, tax on debt mutual funds are go divided into two parts.

(If Invested before April 1, 2023)

Short Term Capital Gain on Debt Mutual Fund

If you have purchased the debt fund before April 1, 2023 and if if the holding period is less then 24 months then short term capital gain tax (STCG) will be applied on you.

Due to which you will be taxed as per your tax slab rates.

Long Term Capital Gain on Debt Mutual Fund

If you have purchased the debt fund before April 1, 2023 and if the holding period of your debt mutual fund is more then 24 months then you will be eligible for LTCG and you have to pay 12.5% LTCG tax on your debt fund gains.

(If Invested After April 1, 2023)

The most important thing to note is that if you invested in debt mutual fund after 1st of April 2023, then there will be no long term capital gain tax on debt mutual fund (LTCG).

All the gains will be considered as short term capital gain on debt fund (STCG) and you will be going to taxed as per your tax slab.

The criteria of holding period for taxability of debt mutual funds is now removed completely.

Of course due to this now you have to pay higher taxes on the gains from your debt fund as compare to the earlier tax pattern.

Indexation Benefit on Debt Funds

After the 2024 new budget the indexation benefit also got removed that an investor got earlier on long term capital gains tax on debt mutual funds.

If you don’t know how indexation benefit can save a lot in taxes.

Then let’s understand this with an example…..

Let’s say you have invested ₹1 Lakh lumpsum in 2021 that have become ₹1.5 lakh by the end 2024 (hypothetical return)

With indexation benefit it will take the inflation value of that ₹1.5 Lakh you got in the form of gain in consideration.

So now when you sell your debt fund you will not be taxed long term capital gains on the profit of ₹50,000.

Let’s say there is constant 5% inflation every year, due to which the inflation adjusted value of ₹1.5 Lakh is equal 1,34,000 (As the value or purchasing power of today’s 1 will decrease as time passes due to inflation)

Hence you will be taxed only on the gains of ₹34,000 instead of ₹50,000.

Isn’t this cool?

But sadly, now this indexation benefit on debt mutual funds has been removed if you have purchased the debt funds after 1 April 2023.

How to Calculate Tax on Debt Mutual Funds

• Purchase Date – The most important thing to calculate the tax on debt funds is to check the purchase date. Check whether you bought the NAV of that debt fund before or after 1 April 2023.
• Calculating Total Capital Gains – As I mentioned above, if you have invested in the debt fund after 1 April 2023 then you have to pay the tax as per your tax slab rate or if you have purchased it before 1 April 2023 then you can check what type of gains will be applicable on you LTCG or STCG based upon the above mentioned conditions.
• Indexation Benefit – If you have invested in debt funds before 1 April 2023, and have a holding period of more then 24 months, then 20% long term capital gain tax will be applied on your debt fund and you will get the indexation benefit too.
• Calculate Tax – Finally, now calculate the final tax based on your tax slab, you can check the New Tax Regime to know under which tax slab you will fall. Finally, just subtract the final selling value of your debt fund from the purchased value & apply the tax slab rate on the you will fall under on the gains.

As per above example the total taxable amount was ₹34,000 with indexation benefit.

But if you have purchased the debt mutual fund after 1 April 2023, then no indexation is applicable on your gains.

Hence, I have to pay the tax on complete ₹50,000 (₹1,50,000-₹1,00,000).

If I fall under 10% tax slab rate then I have to pay 10% of this ₹50,000 that is ₹5,000 as tax to the government.

Frequently Asked Questions

Disclaimer: The Honest American provides stock market news and strategies for informational purposes only and should not be construed as investment advice. Readers are encouraged to consult with a qualified financial advisor before making any investment decisions.