A debt fund is a financial product offered by mutual fund houses. It invests in various fixed-income securities, such as Central Government securities (short-term Treasury Bills and long-term bonds), State Development Loans (SDLs), money market instruments, corporate bonds, etc. A debt fund makes money by:

Debt fund taxation from 1st April 2023

The Government has said the capital gains from debt fund units bought on or after 1st April 2023 will be classified as short-term capital gains. The STCG will be added to the individual’s total income and taxed at their income tax slab. The taxation change applies to debt funds wherein the investment in domestic equities is less than 35% of the scheme’s total assets. The tax change will result in: 1) All capital gains from the above debt funds getting classified as STCG irrespective of the holding period (less than or more than 3 years). 2) The benefit of 20% taxation after the indexation benefit will not apply.

What will be the impact with indexation and without indexation?

With the latest tax changes, debt funds will no longer be able to enjoy the indexation benefit. To understand the impact of this, let us take an example. Jasmine invested Rs. 1,00,000 in a debt fund in 2000. Her investment grew at a 7% CAGR to Rs. 1,22,504 in 2023. During these three years, the inflation rate was 6% p.a. She falls in the 30% income tax bracket. Let us see how Jasmine’s capital gains will be taxed with or without the indexation benefit.

Comparison between debt funds and fixed deposits

After the current changes, the taxation of debt funds is on par with that of fixed deposits. In the case of fixed deposits, the interest amount is added to the individual’s total income and taxed at their marginal tax rate. Similarly, the capital gains from debt funds will be categorised as STCG, added to the individual's total income, and taxed at their marginal tax rate.

Debt fund taxation change: With no indexation benefit, should you still include debt funds in your investment portfolio?

Date : 19/04/2023
Read: 9 mins

Does the removal of the indexation benefit make debt funds less attractive? How do they now compare with bank fixed deposits, and which one should you choose for investment?

During the 2023 Budget Session of Parliament, one of the amendments to the Finance Bill included a key change in the way debt funds are taxed. The change classified the capital gains on debt funds as short-term capital gains (STCG), irrespective of the holding period. The capital gains will not get the benefit of a lower tax rate of 20% with the indexation benefit. The STCG will be taxed at the individual’s marginal tax rate. The taxation change was not announced during the Budget 2023 speech and is a big blow to the debt fund industry. In this article, we will understand the changes in debt mutual funds taxation, the impact with and without indexation, how debt funds compare with fixed deposits after the taxation change, and whether investors should invest in debt funds. What is a debt...

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Debt fund taxation change: With no indexation benefit, should you still include debt funds in your investment portfolio?