Debt Fund Taxation – All You Need To Know
A detailed guide on the tax implications associated with debt funds
- Debt mutual fund scheme primarily invests in fixed income instruments.
- Tax on debt mutual funds depends on whether you invest in dividend-oriented debt funds or growth-oriented debt funds.
- If you choose dividend-oriented funds, you have to pay taxes per your tax slab.
- You have to pay STGC or LTGC taxes on growth-oriented funds.
- Government offers some relief on tax on debt mutual funds.
Mutual funds have risen as one of the most fruitful investment instruments. They help you fulfil your various investment goals and build wealth gradually. The SEBI has segregated mutual fund schemes into five broad categories, with debt funds being one. Let us understand what debt funds are along with debt fund taxation implications in this article.
What Are Debt Funds?
A debt fund is a mutual fund scheme that primarily invests in fixed income instruments, such as government securities, debentures, corporate bonds, and other money-market instruments that offer capital appreciation. Debt funds are considered safer than equity mutual fund schemes because they invest in securities that essentially generate a fixed rate of return. Moreover, debt funds come with a fixed date of maturity, so stock market fluctuations do not significantly affect them.
What Is Debt Mutual Fund Taxation?
Debt funds are ideal investments for conservative investors. They reap stable, fixed returns. As an investor, you should be aware of the types of tax on debt funds you need to pay on capital gains.
Tax on debt mutual funds depends on whether you invest in dividend-oriented debt funds or growth-oriented debt funds. If you choose the Dividend option, you will earn dividends on your debt fund investment periodically. Conversely, if you invest in growth-oriented mutual funds, the profits you earn are reinvested, and the returns you earn are compounded. Opting for growth-oriented debt funds increases the NAV or the Net Asset Value of the funds.
Debt Fund Taxation on Dividend-oriented Funds
If you choose the dividend option, you have to add the dividends, profits, or interest earnings within a financial year to your taxable income at the time of filing returns. You have to pay taxes on these earnings as per your income tax slab.
Debt Fund Taxation on Growth-oriented Funds
You may choose to invest in growth-oriented debt funds. However, the taxes you have to pay depends on whether the gains obtained are over the short or long term. Taxes on Short-term Capital Gains (STCG) are applicable if the holding period for the fund is less than 36 months, whereas you have to pay a Long-term Capital Gains (LTCG) tax if the holding period for the fund is more than 36 months.
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Debt Fund Taxation – The Calculation Process
To understand debt fund tax calculation, you need to know how to determine the gains.
Gains = Asset Value - Cost of Acquisition
Gains = Asset Value - Indexed Cost of Acquisition
Once you calculate the gains accrued on your investment, you can quickly compute debt mutual fund taxation.
Tax on Short-term Gains
As mentioned earlier, short-term gains are added to your income and levied as per your tax slab in a given financial year. You have to pay STCG tax if you exit a debt fund scheme within three years of investment.
Tax on Long-term Gains
The long-term gains are taxed at a rate of 20% after the indexation benefit.
Debt Fund Taxation: How Does It Work?
The Central Board of Direct Taxes or the CBDT, for every financial year, declares what is called a Cost Inflation Index (CII). This CII number is typically displayed in the second quarter or the third quarter of the financial year.
The CII is valued at 75 per cent of the Consumer Price Index (CPI) inflation in the last financial year. However, keeping the previous years’ data in check, it is more than 75 per cent of CPI inflation. This statement confirms that tax authorities are more generous in providing inflation benefits on LTCG on debt funds.
For each financial year, you remain invested, your cost of acquisition (or buying the funds) is ‘indexed’. Now, your capital gains are reached by using this indexed cost of purchase. For taxation purposes, capital gains are calculated by considering the sale price or asset value and subtracting the indexed cost of acquisition.
Now, according to the rate of LTCG, you can calculate the effective tax incidence.
Final noteDebt mutual funds are a great choice if you aim to add security and safety to your investment portfolio. If held for the long-term, debt mutual funds can prove to be highly lucrative investments. Moreover, we have also established that your government offers relief tax on debt mutual funds for long-term investments. You can significantly benefit from investing in debt mutual funds if you belong to the highest tax bracket of 30%. The indexation option allows the investors to reduce the tax payable, making debt funds an excellent instrument for your investment portfolio.
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*Disclaimer: This article is for information only. We recommend you get in touch with your income tax advisor or CA for expert advice.