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Taxation of Debt Funds Post Union Budget 2014 -15 -Tax Planning



You can invest in a debt fund which may be a fixed maturity plan (FMP), debt mutual fund, Monthly income plans (MIP), gold fund or a fund of funds (mutual fund schemes which invest in other schemes of the same or different mutual funds).

Pre-Union Budget 2014-15 -Tax Planning in India



What is short term capital gain tax on a debt mutual fund?
If you sell the debt mutual fund before a year the profits/gains you get are short term capital gains and these are taxed based on the income tax slab you fall under (marginal rate). If you fall in the highest tax bracket the tax rate is 30.9%.If you want to learn more about tax please read An E-book on tax

What is long term capital gain tax on a debt mutual fund?
If you stayed invested in a debt mutual fund for over a year and sold it for a profit it was called a long term capital gain and tax was charged at 10.3% without indexation and 20.6% with indexation.

Without indexation (Long term capital gain)
If you had invested INR 20000 in units of a debt mutual fund in March 2011 and sold these units in September 2012 for INR 25000 (based on the change in its net asset value) a profit of INR 5000 is obtained .This is your capital gain.
• Tax is charged at 10.3% on this gain. You have to pay 10.3 % on the long term capital gain of INR 5000 which is INR 515.
• You have to pay a tax of INR 515 on your profits/gains of INR 5000.

With indexation: (Long term capital gain)
Indexation basically means you take the effects of inflation into consideration while calculating your capital gains.

What is inflation?

Prices of goods such as fruits, vegetables, meat, services such as transport, houses, garments and so on increase with time. This is inflation. Inflation eats into the purchasing power of money and the same INR 100 note fetches much lesser than it would about a year or two ago.

How does inflation affect debt mutual funds?

If you had invested INR 20000 in units of a debt mutual fund in March 2011 and sold these units in September 2012 for INR 25000 a profit of INR 5000 is obtained. INR 20000 does not have the same value (purchasing power) in September 2012 as it had in March 2011 but has a much lesser value with the passage of time due to inflation. Inflation eats up into the purchasing power of money. The capital gains are much larger owing to the effects of inflation not being considered when tax is calculated without indexation. This means you have to pay a higher tax on the capital gains. Indexation saves tax on capital gains by factoring change in the purchasing power of money due to inflation.

The Art of Tax Planning in India:
Changes in the taxation rules of a debt fund after Union Budget 2014-15

  • You have to hold the debt mutual fund for 3 years (36 months) in order for the gains/profits you make to be called long term capital gains. Previously long term capital gains meant holding debt funds for over a year.
  • Before the Union budget 2014-15 if you held debt funds for over a year and sold them at a profit you had long term capital gains which were taxed at 10.3% without indexation. This is now removed.
  • With effect from April 1st 2014 long term capital gains are taxed at 20.6% with indexation.

How do these new tax rules affect you?

  • Suppose you had taken up a debt fund in May 2013 which matures after a year in May 2014. Previously this was a long term capital gain taxed at 10.3% without indexation and 20.6% with indexation.
  • Now you have to hold the debt fund for 3 years for the gains to be classified as long term capital gains. These gains are then taxed at 20.6% with indexation .You can no longer avail capital gains taxed at 10.3% without indexation as this has been scrapped.
  • If the debt fund matures after April 1st 2014 and is held for more than a year but less than 3 years the profit you get is now a short term capital gain as long term gains are classified as 3 years.
Financial Planning
Tax Planning
Investment Planning