The central government has changed the taxation of debt mutual funds: In the proposed amendment Debt Mutual Funds held for more than three years will no longer be referred to as LTCG (long-term capital gains), and so indexation benefit will not be available, applicable from April 1, 2023.
Nobody expected this coming, the government simply decided to eliminate the tax benefit on debt funds.
Until now, the taxes levied on these debt funds are on the basis of a unit’s holding period. If a debt mutual fund unit is redeemed on or before the 36 months, then the gains are considered STCG (short-term capital gains). These STCG are taxed at applicable slab rates. However, if the holding period exceeds 36 months, then gains are referred to as LTCG (long-term capital gains), which are taxed at 20% with an indexation benefit.
What has changed in the taxation of debt mutual funds?
For investments made on the debt mutual fund, on or after April 1, 2023, no indexation benefit will be available. Whether the units are redeemed before or after 36 months, the tax implications are going to be the same.
So, now, the taxes on these debt funds will be levied as per the individual’s slab rate. Let’s say you’re falling under the highest tax bracket, then, will be required to pay 30% income tax rather than the current 20% with indexation.
Importantly, only those debt mutual funds will lose this benefit where the equity portion of the mutual fund scheme does not exceed 35% of Indian companies.
Basically, gains arising from the transfer, redemption, or maturity of such debt mutual fund units are taxed in the same manner as interest income from bank FDs.
Let’s say, you invested ₹5 lakhs on April 6 2023 on a debt fund and you sell it after 3.2 years for ₹8 lakhs. So, here the gains of ₹3 lakhs ( ₹8 lakhs - ₹5 lakhs) will be taxed at slab rates depending on the tax regime you choose.
If now, anyone wants to avail of the tax benefit of indexation, you have a small window until March 31, 2023, to invest in debt mutual funds. You can get the indexation benefit till the investments are redeemed from mutual funds.
What is Indexation Benefit?
Indexation is simply a benefit that allows you to adjust the cost of acquiring long-term assets considering inflation when calculating the taxes on selling these assets.
After considering inflation, the returns calculated are generally lower than your actual returns. Indexation rates for the period of your investment can be calculated using the CII (Cost Inflation Index) figures. Every year, the government releases the CII figures, which represent the year’s inflation rate.
What other types of mutual funds are affected?
Apart from debt funds, indexation benefit will not be available in the case of LTCG on gold mutual funds, international equity mutual funds, fund of funds, and as well hybrid mutual funds, where not more than 35% is invested in equity shares of the Indian companies. Hence, will be taxed at normal slab rates.
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