According to the new tax laws applicable from April 1, 2023, the indexation benefits available on LTCG generated from debt mutual funds (as well as all Mutual Funds with not more than 35% exposure to equity shares of domestic company) is scrapped. Read this post to know more.
The indexation benefit on the Long-Term Capital Gains (LTCG) generated from debt mutual funds gave them an edge over investments like Fixed Deposits (FDs). It allowed the investors to adjust the security's purchase price according to the Cost Inflation Index (CII), annually updated by the RBI. The indexation benefit helped investors reduce the tax burden on the gains.
But during her Budget 2023 speech, Finance Minister Nirmala Sitharaman the Finance Act 2023 proposed scrappeding this indexation benefit for LTCG on debt mutual funds from April 1, 2023. Let’s try to understand the updated debt mutual fund taxation in detail-
Debt Mutual Fund Taxation Before April 1, 2023
The taxation on the capital gains generated from debt mutual funds relied on the period for which the investors held the investment. Units sold within 3 years from the date of purchase were considered Short-Term Capital Gains (STCG). Similarly, investments redeemed after a holding period of 3 years were considered Long-Term Capital Gains (LTCG).
Here’s how these gains were taxed before Finance Act 2023-
Type of Mutual Fund |
Debt Mutual Funds |
STCG Tax |
Gains are added to the investor's taxable income and taxed as per their tax slab. |
LTCG Tax |
Taxed @20% (plus applicable surcharge and cess) with indexation benefit |
Example
Mr Navin invested ₹1 lakh in a debt mutual fund in FY2016-17 and redeemed the investment in FY2022-23. As the holding period was more than 3 years, the gains will be taxed as per the LTCG tax rules. Let's assume the sale value was ₹1.5 lakhs. Here's how the gains were taxed-
Particulars |
FY |
CII |
Amount (₹) |
Purchase |
2016-17 |
264 |
100,000 |
Sale |
2022-23 |
331 |
150,000 |
Indexed Investment Cost |
(100,000 x 331/264) |
125,378 |
LTCG |
(150,000-125,378) |
24,622 |
Tax Payable |
@20% |
4,924 |
Debt Mutual Fund Taxation After April 1, 2023
According to the new debt fund taxation rules, the indexation benefit on LTCG is no longer available for investments undertaken on or after 1 April 2023. Instead, the gains will be added to the investor's taxable income and taxed as per their tax slab. All gains on debt fund units acquired on or after 1 April 2023 shall be considered as STCG irrespective of the holding period. Indexation benefit on LTCG shall continue for debt mutual fund units acquired before 1 April 2023 and sold on or after 1 April 2023.
Here are the updated tax rules for debt mutual funds after April 1, 2023-
Type of Mutual Fund |
Debt Mutual Funds |
STCG Tax |
Gains are added to the investor's taxable income and taxed as per their tax slab. |
|
|
Example
Let's assume Mr Navin invested ₹1 lakh in a debt mutual fund in FY2023-24 and redeemed the investment in FY2028-29 at a sale value of ₹1.5 lakhs. According to the new tax rules, the gains will be taxed as follows-
Particulars |
FY |
CII |
Amount (₹) |
Purchase |
2023-24 |
- |
100,000 |
Sale |
2028-29 |
- |
150,000 |
STCG |
(150,000-100,000) |
50,000 |
Tax Payable* |
|
15,000 (30% tax bracket)
10,000 (20% tax bracket)
5,000 (10% tax bracket) |
How Will the New Debt Fund Tax Rules Impact Investors?
As seen above, the scrapping of indexation benefit on LTCG from debt funds will increase the investors' tax outgo, especially those from the 20% and 30% income tax slabs. Moreover, as the new tax rules have made taxation of debt schemes similar to bank deposits, investors can find it challenging to choose between the two.
However, debt mutual funds still have other advantages over Fixed Deposits (FDs). For instance-
Investors only pay taxes on debt fund investments after redeeming the scheme units. Thus, they can be used for deferring taxes.
Many debt funds have an exit load. But after holding the investment for a certain duration, investors are free to redeem the investment as and when they like without any penalties. Premature withdrawal from standard FDs always attracts a penalty.
Compared to bank FDs, some debt mutual funds can deliver potentially higher returns.
Investing in Debt Mutual Funds
As taxes play a vital role in investments, every investor should understand at least the basics of mutual fund taxation before investing. If you're planning to invest in debt funds, note the latest changes to the tax rules to avoid any discrepancies in the future.
Also read: How is the Tax Liability in Debt Mutual Funds Calculated?
A professional investment or tax advisor can also assist you in choosing the right, tax-efficient investments according to your objectives.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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