Debt mutual funds are investment options that primarily invest in debt and money market instruments. These include funds like Liquid Funds, Corporate Debt Funds, Credit Risk Funds, and more. However, the taxation rules for these funds have changed, especially from April 1, 2023. In this article, we will break down these changes and explain how they affect taxpayers, in a way that’s easy to understand.
1. What Are Debt Mutual Funds?
Debt mutual funds invest at least 65% of their assets in debt and money market instruments. These funds are considered safer compared to equity funds and offer steady returns. However, the taxation of these funds has seen frequent changes, leaving many investors confused about how to calculate tax when they sell (redeem) their units.
2. How is Tax on Debt Mutual Funds Calculated?
The tax treatment of debt mutual funds depends on the purchase date. Let’s break it down based on the changes made from April 1, 2023:
Debt Mutual Funds Purchased on or After April 1, 2023:
These funds are taxed at the income tax slab rate of the investor, regardless of how long the investment is held. If the investor's income is low, they may also be eligible for a rebate under Section 87A.Debt Mutual Funds Purchased Before April 1, 2023:
The tax treatment for these funds depends on the redemption date. Let’s look at these scenarios.
3. Tax on Debt Mutual Funds Purchased After April 1, 2023
Tax Rate:
If you buy debt mutual funds on or after April 1, 2023, your capital gains (profits from selling the units) will be taxed according to the income tax slab that applies to you. This means if your income is in a lower tax bracket, you’ll pay less tax.Tax Rebate under Section 87A:
For investments made after April 1, 2023, you can qualify for a tax rebate under Section 87A, provided your income is below a certain limit. This rebate reduces the tax you need to pay on your capital gains.
Example:
- Mr. Arvind bought debt mutual fund units in June 2023 for Rs. 5,00,000 and sold them in April 2025, making a profit of Rs. 1,00,000. If his total taxable income for FY 2025-26 is Rs. 6,00,000, he would pay tax on the Rs. 1,00,000 capital gain according to the income tax slab applicable to him. Additionally, he would get a Rs. 60,000 rebate under Section 87A, meaning his tax liability would be zero.
If Mr. Arvind sold the units before April 1, 2025, his rebate would be Rs. 25,000 instead, as per the slab rate for FY 2024-25.
4. Tax on Debt Mutual Funds Purchased Before April 1, 2023
- Redemption Before July 23, 2024:
If you bought debt mutual funds before April 1, 2023, and sold them before July 23, 2024, long-term capital gains were taxed at 20% with indexation (adjusting the purchase price for inflation). You could take advantage of this benefit if the units were held for more than 36 months.
Example:
Mrs. Priya bought debt mutual fund units in 2020 for Rs. 1,00,000 and sold them in 2023 for Rs. 3,50,000. The capital gains tax would be calculated as:
- Indexed cost of acquisition: Rs. 1,20,000 (adjusted for inflation)
- Capital gain = Rs. 3,50,000 – Rs. 1,20,000 = Rs. 2,30,000
- Tax = 20% of Rs. 2,30,000 = Rs. 46,000
Redemption After July 23, 2024:
For debt mutual funds purchased before April 1, 2023, and redeemed after July 23, 2024, the tax rate drops to 12.5%, and there is no indexation benefit. Additionally, the holding period to qualify for long-term capital gains is reduced to 24 months.
Example:
- Mr. Deepak bought debt mutual fund units in March 2022 for Rs. 2,00,000 and plans to sell them in April 2025, making a capital gain of Rs. 5,00,000. After considering the basic exemption limit of Rs. 4,00,000, the capital gains tax will be:
- Capital gains subject to tax: Rs. 1,00,000
- Tax = 12.5% of Rs. 1,00,000 = Rs. 12,500
If Mr. Deepak redeems the units before April 1, 2025, his capital gains would be taxed based on the slab for FY 2024-25, leading to a higher tax liability.
5. Summary of Taxation Rules for Debt Mutual Funds
The tax treatment of debt mutual funds can be summarized as follows:
| Sl. No. | Date of Purchase | Date of Redemption | Tax Rate | Holding Period | Remarks |
|---|---|---|---|---|---|
| (a) | On or after 01.04.2023 | FY 2025-26 | Applicable Slab Rate | NA | Qualifies for rebate of Rs. 60,000 under Section 87A |
| (b) | On or after 01.04.2023 | FY 2024-25 | Applicable Slab Rate | NA | Qualifies for rebate of Rs. 25,000 under Section 87A |
| (c) | Before 01.04.2023 | Before 23.07.2024 | 20% with indexation | 36 Months | NA |
| (d) | Before 01.04.2023 | Before 23.07.2024 | Applicable Slab Rate | < 36 months | Qualifies for rebate under Section 87A |
| (e) | Before 01.04.2023 | After 23.07.2024 | 12.5% without indexation | 24 months | NA |
| (f) | Before 01.04.2023 | After 23.07.2024 | Slab Rate | < 24 months | Qualifies for rebate under Section 87A |
6. Conclusion
The taxation of debt mutual funds has become more complex with the latest changes, especially from April 1, 2023. To minimize tax liability, it’s important to know the purchase date of your investment and plan redemptions carefully. For investments made after April 1, 2023, taxpayers may qualify for a rebate under Section 87A, reducing their tax burden.
By staying informed about these changes, you can make better investment decisions and optimize your tax planning.
