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What is Taxation of Debt Mutual Fund?

What is Taxation of Debt Mutual Fund?

Published on 15 December 2021 .Views 95 .Comments 0
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  1. What is a Debt Mutual fund?

"Debt" the word itself means loan. Debt mutual fund gives loans to government, businesses and financial institutions, and hence Debt funds invest into fixed income securities such as Treasury Bills, Government Securities, Corporate Bonds, Money Market instruments and other debt instruments of different time horizons.

  1. How is a Debt Mutual Fund Taxed? 
    1. Short term Capital Gain- When Debt Mutual Funds are sold within 36 months from the date of purchase, the profit or loss on redemption is known as Short-Term Capital Gain or Loss (as the case may be). Short Term Capital Gain is taxable as per the normal tax slab rate and indexation benefit is not available for the same.
    2. Long-Term Capital Gain- When Debt Mutual Funds are sold on or after 36 months from the date of purchase, the profit or loss on redemption is known as Long-Term Capital Gain or Loss (as the case may be). Long-Term Capital Gain on redemption of Debt funds is taxable @ 20%. Indexation benefit is available in case of LTCG.
  1. What is Indexation?

Indexation means adjustment of gains with respect to Inflation i.e. subtracting the impact of inflation on your returns and then paying taxes. Inflation here is calculated based on CII (Cost Inflation Index) provided by Income tax department each year. Let us understand the calculations with an example.

Example: Suppose you invested ₹10 lakhs in 2010-2011 in a Debt Fund. Assume the fund returned 10 percent a year, and you redeem it for ₹16,10,510 after 5 years i.e. in 2015-16. Since you sold the fund after 36 months of holding period, your capital gains will be considered as Long term Capital gains. Capital gains in this example would be ₹6,10,510 (Redemption amount – Invested Amount).

Now CII (available on Income Tax Dept. website) for 2010-11 was 167 and 2015-16 was 254. So, we will adjust the value of our investments made in 2010-11 to the value of the same investments which stand as of 2015-16 i.e. year of redemption.

The calculation is done as follows:

(CII at redemption Year/CII at Investment Year) X Invested amount = Indexed Investment amount

254/167*10 Lakh = ₹15,20,958 (Indexed Investment Amount)

So, now the long-term capital gain would be

Redemption amount - Indexed Investment amount = ₹16,10,510 – ₹ 15,20,958 = ₹89,552

A 20% taxation on this amount would be ₹17,910. This is less than 3% of your gains (₹6,10,510). Hence, we will be paying taxes on the returns earned over and above the inflation adjusted initial investment.

  1. Dividend Distribution Tax:

As proposed in Budget 2020, companies will not be required to pay Dividend Distribution Tax (DDT). Dividend income from mutual funds is now taxable in the hands of the recepient at applicable income tax rates.

Important points

  • Fund of funds and international funds are considered as debt funds for the taxation purpose and are taxed accordingly.
  • As far as taxation goes, Mutual funds are either categorised as equity or debt and taxed accordingly So incase of hybrid funds, if the fund’s portfolio is holding more than 65% of its assets as investments in the domestic equity market, then the fund is termed as an Equity Fund. Else, it is termed as a Debt fund and taxed accordingly.
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