Home Banking New Debt Fund Taxation Rules: Here’s What Investors Should Know

New Debt Fund Taxation Rules: Here’s What Investors Should Know

Debt Fund Taxation

The indexation benefits on LTCG generated by debt mutual funds (as well as all mutual funds with no more than 35% exposure to equity shares of domestic companies) are no longer available under the new tax regulations, which take effect on April 1, 2023. To learn more, read this article.

Debt mutual funds had a benefit over other investments like fixed deposits (FDs) in the form of the indexation benefit on the long-term capital gains (LTCG) they earned. The Cost Inflation Index (CII), which the RBI updates yearly, was used to allow investors to alter the security’s purchase price. Investors’ tax liability on the gains was decreased thanks to the indexation benefit.

But in her Budget 2023 address, Finance Minister Nirmala Sitharaman suggested eliminating this indexation benefit for LTCG on debt mutual funds as of April 1, 2023, as part of the Finance Act 2023. Let’s attempt to comprehend the revised debt mutual fund taxation in further depth.

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Before April 1, 2023, debt mutual fund taxes

Taxation on capital gains resulting from investments in debt mutual funds was dependent on how long the investors kept the investments. The term “Short-Term Capital Gains” (STCG) applied to units sold within three years of the purchase date. Likewise, investments that were redeemed after a holding period of three years were regarded as Long-Term Capital Gains (LTCG).

Taxation of Debt Mutual Funds After April 1, 2023

The indexation benefit on LTCG is no longer accessible for investments made on or after 1 April 2023, per the new debt fund taxation regulations. The gains will instead be included in the investor’s taxable income and taxed according to their tax bracket. Regardless of the holding duration, all profits on debt fund units purchased on or after 1 April 2023 will be treated as STCG. For debt mutual fund units purchased before 1 April 2023 and sold on or after 1 April 2023, the indexation benefit on LTCG will be maintained.

How Will Investors Be Affected by the New Debt Fund Tax Rules?

As was mentioned above, the elimination of the indexation benefit on LTCG from debt funds would result in a rise in tax expenses for investors, particularly those in the 20% and 30% income tax brackets. In addition, since debt schemes are now taxed similarly to bank deposits under the new tax laws, investors may find it difficult to decide between the two.

Fixed Deposits (FDs) still have some advantages over debt mutual funds, nevertheless. For example-

  • Taxes on debt fund investments are only due by investors once the scheme’s units have been redeemed. They can thus be used to postpone paying taxes.
  • An exit load is present in many debt funds. However, investors are free to redeem their investment whenever they choose and without incurring any fees after keeping it for a specific period of time. There is always a penalty for premature withdrawal from ordinary FDs.
  • Some debt mutual funds may offer larger returns than bank FDs.

In India, how are debt mutual funds taxed?

On investments in mutual funds, there are two main tax obligations in India.

  • Capital gains tax 
  • Dividend tax

While capital gains tax is based on the type of fund and the holding period, dividends are added to the investor’s income and taxed at the corresponding tax slab rate.

For taxation purposes, all mutual funds in India fall into one of two categories: equity funds or debt funds. Tax obligations for equity and debt funds are different. A debt fund is defined as a strategy that invests less than 65% of its portfolio in equities.

How Do I Select the Best Kind of Mutual Fund?

Every category of mutual funds offers a number of different scheme possibilities from different fund firms. Following the selection of a fund category, follow these steps to select a plan from that category:

Scheme Execution

Start by contrasting the scheme’s long-term performance with the best in its category. Look for investments that have consistently produced positive returns over a 5- and 10-year timeframe.

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Money Manager

Any mutual fund scheme’s performance depends significantly on the fund manager. Make sure the fund manager overseeing the scheme you select has experience.

Ratio of Expenses

You pay the fund house a fee for managing your investment, which is known as the cost ratio. Lower returns on your investment are the result of a greater expense ratio as well as increased fund house fees.

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