Checkout the new rules for taxing capital gains on debt funds

Debt mutual fund taxation has been a prominently discussed topic since its amendment in the Finance Bill 2023. According to the changes, no debt fund indexation benefits will be available on investments performed on or after 1st April 2023. This change appears to bring debt fund taxation on par with fixed deposits, allowing the Indian government to stiffen the arbitrage used by high-net-worth individuals to lower their tax burden. Explored here is the debt fund taxation amendment in detail. However, before this, let’s understand what a debt mutual fund is. 

What are debt funds? 

Debt funds are a mutual fund category that basically invests your investible in fixed-income securities like debentures, bonds, money market instruments, etc. The returns are generated in the form of capital appreciation or interest pay-out, making this investment instrument best for risk-averse investors. Besides this, their characteristics like stability and capital preservation also play a crucial role in making them an ideal instrument for low-risk investors. 

As debt mutual funds ensure consistent and predictable return on investment, they offer a regular income stream in the form of periodic interest pay-out if opted for the dividend option. Note that during market downturns or economic uncertainties, debt investments tend to offer better capital protection than equities, as they maintain their face value and continue to provide interest pay-outs. So, by focusing on better quality debt mutual fund schemes, you can mitigate the risk of default and enjoy the stability and security offered by debt investments.

What were the old debt fund taxation rules?

Until the amendment, the debt fund taxation was based on the holding period and indexation rules. If debt funds were redeemed before or on completion of three years, then they were termed as short-term capital gains and taxed as per your income tax slab. 

However, if the period of holding surpassed 3 years, then the gains generated on debt mutual funds were addressed as long-term capital gains. Such gains were taxed at 20 per cent along with indexation benefits. In simpler terms, the gains generated were adjusted as per inflation, lowering the tax liability. 

What are the new debt fund taxation rules?

As per the recent amendments in the debt fund taxation rules, no indexation benefits on long-term capital gains would be provided on investments on and after 1st April 2023. This means the debt mutual funds will now only be taxed according to your income tax bracket. Besides this, indexation benefits would also not be provided for long-term capital gains on international equity funds, gold mutual funds, hybrid mutual funds, and funds of funds. 

Final words

The new capital gains tax rules on debt funds bring this instrument on par with fixed deposits. While this change has increased the tax outgo of retail investors, it is still an imperative financial option. This is because, this financial option has the potential to generate higher returns than traditional fixed-income instruments like fixed deposits, public provident funds, employee provident funds, etc. owing to its association with the market. So, by investing in debt mutual funds, you can still earn higher returns and reach your short-term goals within the estimated timeframe. 

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