Skip to main content

Updated tax regulations for debt mutual funds: What investors need to know.

updated tax regulations for Debt funds
Share :

When investing and calculating potential returns, it’s important to consider tax implications on returns to ascertain the true value of your investments. Investing without factoring tax implications can lead to unexpected tax liabilities and missed tax-saving opportunities.
As per the recent amendment to The Finance Bill, 2023, capital gains from debt mutual funds will be taxed at your income tax slab rate. So, what does this mean? Here, we’ll have a close look at updated tax regulations for debt mutual funds. But first, let’s understand what a debt fund is.

What are debt mutual funds?

With debt mutual funds, one can invest in various fixed income securities, including treasury bills, corporate bonds, commercial papers, government securities, and other money market instruments. These securities have predetermined maturity dates and interest rates, providing investors with fixed income upon maturity, hence the term "fixed-income securities".

Taxation of debt mutual funds

Until March 31, 2023, capital gains arising from the redemption of a debt fund held for at least three years were categorized as long-term capital gains (LTCG) and were subject to a fixed tax rate of 20% after indexation.

New amendment and its impact

From April 1, 2023, onwards, capital gains earned from debt mutual funds, exchange-traded funds (ETFs), international funds, gold funds, and specific categories of hybrid funds that invest less than 35% in Indian equities will be included in your taxable income and subject to taxation at the applicable slab rate. The previously available long-term capital gains (LTCG) tax benefits and indexation benefits on debt mutual funds will no longer be applicable.

Debt funds and equity funds usually have a minimum of 65% of their investments in debt securities or equities, respectively. However, as per the new tax rule, non-equity funds with less than 35% of investments in equities will no longer be eligible for the long-term capital gains (LTCG) tax rate of 20% with indexation, effective from April 1, 2023. This tax advantage was a significant reason why many investors preferred debt investments, but it is no longer available.

How proposed changes would impact tax outflow

Several hybrid funds with over 35% investments in equities will still retain the tax advantage. Recent developments have led to expectations that arbitrage funds will particularly benefit from the new tax rules. Additionally, other funds like, Multi Asset, and Equity Savings are likely to see renewed interest among investors.

Nonetheless, not all investors who previously invested in debt funds may find hybrid funds suitable based on their risk profile and investment objectives.

As hybrid funds have specific investment objectives and underlying holdings, investor interest is not solely driven by the tax treatment of returns. As a result, there may not be a significant shift in investor perception due to the recent developments.

Some investors may choose to continue with debt funds even without the tax advantage if they perform well in other aspects, such as risk management or historical performance.

To sum it up, the recent changes in taxation rules have not impacted the advantage of LTCG tax at 20% with indexation for non-equity funds that have more than 35% investment in equities. Therefore, there are still many hybrid funds that meet this criterion.

Tax efficiency plays a significant role in driving investment decisions across various avenues, including insurance, bonds, mutual funds, equities, NPS, PF, and alternative investments. Investors tend to prefer avenues with lower taxation on returns.


What are the types of tax on debt mutual funds?

Debt funds are subject to two types of taxes based on their holding period, namely Short-term Capital Gain (STCG) tax and Long-term Capital Gain (LTCG) tax.

How much tax do you pay on debt mutual funds losses?

As per the Income-tax Act, an individual is allowed to offset their losses against taxable profits. However, long-term capital losses can only be set off against long-term capital gains and cannot be set off against short-term capital gains, despite both falling under the same head of capital gains.

Are debt mutual funds tax-free?

No. Debt fund investments will be subject to taxation based on the applicable slab rates. The previously available long-term capital gains (LTCG) tax benefits and indexation benefits on debt mutual funds will no longer be applicable.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.

This document should not be treated as endorsement of the views/opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.