Returns from debt mutual funds will now be taxed according to existing income tax slabs. Investors can no longer avail indexation benefits on debt fund returns. This means that debt funds will now be taxed like fixed deposits. However, any investment made before 31 March, 2023 will still benefit from indexation.
The new taxation rules for debt funds had been proposed in the Finance Bill which was passed by the Parliament on Friday, 24 March.
What does this mean for your investments? To understand that, let’s see how indexation works.
What is indexation? How does it work?
First, let’s set the context by taking a look at how indexation works and what are its benefits.
Currently, if a debt fund is held for more than three years, then it is taxed at 20% after adjusting for indexation. Let’s understand this with an example: Suppose, four years ago in FY19, you invested ₹1 lakh in a debt fund and earned an interest of ₹20,000. The cost inflation index was 280 in FY19 and for the current financial year it’s 331.
As highlighted in the table above, after the indexation, in the case of debt funds, the tax (20%) will be levied only on ₹1,786 and not the entire ₹20,000. This means your overall tax liability reduces.
What has changed now?
But, under the new rules, debt fund investors won’t be able to enjoy the benefits of indexation. Even if investors are putting money in a debt fund (which doesn’t have more than 35% invested in equities) for more than three years, they will be taxed as per their income tax slab. Also, even if a debt fund is held for more than three years, tax will be levied according to the income tax slabs.
Experts believe that the government wants to bring all debt instruments including fixed deposits at par. However, this could adversely affect the raising of money in the debt market.
It’s also important that all existing and new investments made before 31 March 2023 won’t be affected by these changes.
Impact on other categories
Currently, gold and international mutual funds have a similar tax structure as the debt mutual funds. However, with the indexation benefits being removed, gains on gold and international mutual funds will also be taxed as per an individual’s relevant tax slab.