Debt Mutual Fund Taxation

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Taxation on Debt Mutual funds under section 10(35)

There are two types of taxation relevant to debt mutual funds:

  • Capital gains tax depend on Dividend Distribution Tax income or dividend announced on your debt mutual fund purchase
Type Of Tax Tax Rate
Short Term Capital Gains Tax
Resident Indian As per an individual’s income tax bracket
Non-Resident Indian As per an individual’s income tax bracket
Long Term Capital Gains Tax (under section 112)
Resident Indian 20% (with indexation benefit)
Non-Resident Indian On listed funds- 20% (with indexation benefit) On unlisted funds- 10% (without indexation benefit)
Dividend Distribution Tax (DDT) At the rate of 28.84% (including surcharge and cess) for individuals and HUF(under section 115R)

What are Debt Mutual Funds?Debt Mutual Funds Taxation

A debt mutual fund is a type of mutual fund system in which a notable proportion of assets under administration is principally invested in fixed income securities, including bonds and debentures. They fall in the classification of “Non-Equity Mutual Funds”, which are defined as funds with less than 65% of their portfolio invested in equity and equity-related instruments. All mutual funds, including debt mutual funds, balanced funds, gold funds, money market funds etc., are categorized as non-equity mutual funds.

For instance – liquid mutual funds, gold funds, money market funds, infrastructure debt funds.

How is capital gains tax computed on debt mutual funds?

Capital gains occurring on the transaction of debt mutual funds attract capital gains tax. The sale will attract short-term capital gain tax or a long-term capital gain tax based on the holding duration.

  • Long-term capital gains: If you want to sell your stake in a debt mutual fund after 3 years of holding duration, capital gains stemming from such transaction is listed as a long-term capital gain (LTCG) and will be charged at a long-term capital gains tax rate. Long-term capital gains are qualified for indexation privilege. The cost of obtaining an asset is modified for changes in the cost inflation index during the holding phase. In case of an escalation in the index, the cost of acquisition is regulated upwards, reducing the quantum of capital gain and, consequently, capital gains tax. The price files used for the adjustment are managed and released by the IT department.
  • Short-term capital gains- If you sell your stake in a debt mutual fund in less than 36 months (3 years), capital gains arising from the transaction is classified as a short-term capital gain (STCG) and will be taxed at short term capital gains tax rate.

Case 1: Calculation of capital gains tax if you sell a debt mutual fund after 3 years of holding

Mr Gopal, an Indian resident, sells his stake in a debt mutual fund at ₹ 15,000 on 20th March 2017. He had acquired the scheme ₹ 10,000 on 10th March 2014. What will be his property gains tax liability? Mr Gopal earns a capital gain of ₹ 5,000 on his sale purchase. Since his holding duration is more than 3 years, he is liable to pay capital gains tax rate of 20% and is also qualified for indexation privilege.

Cost Inflation Index for 2016-2017 is 1125 and was 939 in 2013-2014 when Mr Gopal acquired the scheme. After implementing the change in the Cost Inflation Index (10,000*1125/939), the indexed cost of purchase stands at ₹ 11,981. His capital gain is ₹ 3,019. At a rate of 20%, Mr Gopal is responsible for paying a tax of ₹ 604 as capital gains tax on his debt mutual fund’s clearance.

Computation Of Capital Gains Tax Rs.
Sale proceeds of debt mutual fund (1) 15,000
Cost of Acquisition (2) 10,000
Indexed Cost of Acquisition (3) 11,981
Long Term Capital Gains (4)= (1)-(3) 3,019
Long Term Capital Gains rate @20% (4)%20% 604

Case 2: Computation of capital gains tax if you sell a debt mutual fund before 3 years of holding

Mr Pankaj, an Indian Resident, sells his stake in debt mutual funds at ₹ 10,000 on 25th March 2017. He had acquired the scheme at ₹ 5,000 on 15th March 2016. Mr Pankaj comes under the marginal tax rate section of 25%.

Since Mr Pankaj’s holding duration is less than 3 years, he is subject to pay short capital gains tax on the property raises coming up from the sale at the rate of 25%. Mr Pankaj earns a capital gain of ₹ 5,000 on his sale purchase. Applying a tax rate of 25%, he is likely to pay a capital gains tax of ₹ 1,250 on his property gains of ₹ 5,000 (5,000* 25%).

Indexation benefit relates to adjusting the cost of acquiring an asset for changes in the cost expansion index during the holding phase. In the case of a rising cost inflation index, this regulation would increase procurement cost, thus reducing the quantum of funds gain and hence, capital gains tax. The cost inflation index per year used for the adjustment is managed and released by the IT department.

How much is dividend distribution tax (DDT) charged on debt mutual funds?

A dividend distribution tax(DDT) governs any distribution of revenue on debt mutual funds at the rate of 28.33% (including surcharge and cess) for Individuals and HUF investors. Asset authority businesses deduct DDT from dividends before crediting earnings in the account of debt mutual fund holders.

FAQs about Debt Mutual Funds

Is debt mutual fund tax-free?

No, debt mutual funds are not tax-free. The tax charged on debt mutual funds is based on short-term and long-term capital gains.

Is Debt fund better than FD?

Debt funds and fixed deposits offer high returns with low risk on investment. Some of the common differences between FD and debt funds are:

  • Tenure: FDs are for a fixed duration of time while there is no such fixed duration on a debt fund.
  • Liquidity: Debt funds have high liquidity than fixed deposits since Loanees can redeem them at any point.
  • Volatile: Returns are volatile on debt while fixed in FDs.

How do you calculate tax on debt funds?

Long-term capital gains on debt funds are taxable at the rate of 20% after indexation. At the same time, an individual is required to add short-term gains from debt funds to his overall income. They are subject to short-term capital gains tax and are taxable according to the income tax slab.

 How do private debt funds work?

Private debt involves the lending activity done by entities other than banks. This can include lending by more specialized entities or Peer to Peer lending. Visit Dialabank to know more about taxation on Debt Mutual Funds.

Why is debt better than equity?

Debt is considered better than equity because of the following reasons:

  • Debt does not dilute the owner’s ownership interest in the company.
  • Interest on the debt can be deducted from the income tax.
  • Raising debt capital is less complicated.
  • A lender has no direct claim on future profits of the business.