How Returns Are Taxed On Debt Mutual Funds

By BankBazaar | November 29, 2018

It’s unwise to step into the world of Debt Mutual Funds without taking into consideration the various tax implications that your investments may attract. If you’re losing sleep over tax worries, here’s all that you need to know to put your mind at ease.

Tax can prove to be a quite a tough nut to crack if you are just starting out with Mutual Funds.

But, worry not – with a little bit of patience, you can tap into this seemingly complex and mundane world of tax and learn to make it work in your favour.

If you are invested in Debt Mutual Funds, here’s all the tax gyaan you need to get the maximum returns out of your investments.

Capital Gains: 

Any profit that rises out of the sale of your investments in Debt Mutual Funds will be considered as capital gains. For the purpose of taxation, capital gains are of two types: short-term and long-term.  If your investment period from the date of purchase is less than 3 years, the capital gain arising out of it will be considered as short-term capital gain. If you have held your investments for more than three years, it will be considered as long-term capital gain.


  Investment Holding Period  Taxation 
Short-Term Capital Gain  36 months or less Added to income and taxed as per applicable slab rate
Long-Term Capital Gain  More than 36 months 20% with indexation

Tax on Short-Term Capital Gain

If you plan to withdraw your Debt Mutual Fund investments in less than three years from the date of purchase, you will have to pay taxes as per your income tax bracket. For instance, if you draw a salary of Rs 12,00,000 per annum, you fall in the 30% tax zone. If the total gain earned from your debt fund is Rs 15,000, you will end up paying 30% as taxes. So, you would pay Rs 4,500 as tax (30% of Rs 15,000) and get Rs 10,500 ((Rs 15,000- Rs 4,500) as your net return.

Tax on Long-Term Capital Gain

Now, if you decide to sell off your investments after having held them for more than 3 years, your investments will come under the purview of long-term capital gain.  In such a situation, you will have to pay tax at the rate of 20% after indexation.

Additional Reading: What Are Capital Gains? How Are You Taxed For It?

How does Indexation add value?

Not many people who invest in Mutual Funds are aware of this extremely useful tool called Indexation. Indexation offers great tax benefits for long-term investors.

Note: Indexation benefits are not applicable to those who are short-term investors in Debt Mutual Funds.

It inflates the purchase price using cost inflation index to reflect the effect of inflation. So, the tax burden on you reduces significantly, therefore, helping you get more returns out of your investments.

Debt Mutual Funds Are Great For Long-Term Investors

If you are investing in Debt Mutual Funds, it is advisable to pack in for the longer haul. The simple reason being – a quick exit may turn out to be a costly affair. Capital gains tax will gnaw into your investments and erode your wealth if you decide to exit without keeping the time horizon in mind.

The ideal time-period for holding your Debt Mutual Funds should at least be 3 years. If you have a short-term horizon, you could try opting for liquid funds, which offer good returns with better flexibility. When it comes to Debt Mutual Funds, the longer you stay invested, the better your chances of maximising your returns.

Finally – What Is DDT And How Does It Affect You?

Dividend Distribution Tax (DDT) is a tax that companies pay to the government for the dividend they are paying to their investors. Since fund houses deduct the DDT before paying out the dividends to its investors, a higher DDT automatically reduces the in-hand returns of the investors. Currently, any distribution of income on Debt Mutual Funds is subject to a DDT at the rate of 29.12%, before the proceeds are passed on to the investors.

The Way Ahead

Since taxes are an inseparable component of Mutual Funds, it is important for you as an investor to plan your strategy well. Be sure of your investment goals and never make a hasty exit. Think and observe. You’ll soon learn to make taxes do your bidding.

Whether you are a newbie hunting for your first buy or a seasoned investor on the prowl, BankBazaar has in store for you a world full of limitless possibilities.

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