Debt Funds Taxation in Detail

(Last Updated On: May 7, 2017)

Taxation treatment is an important aspect of investment in Debt Funds. This post discusses about Debt Funds Taxation in detail

Debt Funds Taxation

Everyone would like to earn more and more income and want to achieve their financial goals in life. With the increase in income, the income tax burden also increases. The higher the income, higher is the tax rate. People want to minimise the tax liability in legal ways so as to have more of their hard earn money in their hand. The government has also given certain ways through which everyone can save tax. Mutual funds also enjoy certain taxation benefits. One can invest in equity mutual fund or debt mutual fund depending upon his or her risk bearing capacity, age, time horizon, financial goal etc. In this post we will have a look at debt funds taxation.

Let us understand more about taxation of the debt mutual fund.

How are debt funds taxed

There are various kinds of debt fund namely, Short term, Fixed Monthly Plan, Ultra short-term, liquid and gilt fund. The taxation of all kind of debt funds is similar.

The returns from funds are characterised short term and long term. In case, of debt mutual fund, if a unit of debt mutual fund is held by an investor for more than 36 months from the date of unit purchase, then it is to be considered as long-term capital gain. On the other hand, if units are sold within 36 months from purchase, then it is considered as short term capital gain.

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The holding period of 3 years based on which gain or loss classified as the long or short term was introduced in budget 2013-14. Before this, long term was considered if holding of funds for more than 1 year and less than 1 year classified as short-term capital gain. Also in case of long-term capital gain, the

In case, of short-term capital gain, the investor has to pay tax as per the applicable income tax slab. Such gain will be added to total income and accordingly tax limit is ascertained.  For example, Mr. X is in the tax slab of 10% and if there is short term capital gain then he has to pay tax @ 10% on such gain.

While in long-term capital gain, the investor has to pay tax @ flat 20% of the gain with the benefit of cost indexation. Which means the absolute gain of investor will reduce by taking into effect the inflation rate. This will eventually reduce the income or gain which is liable for the tax. Previously before the introduction of budget 2013-14, the rate for long-term capital gain was 10%.

Just to sight more focus on and bring more clarity, I am going to explain this with a hypothetical example.


Tax on Short-term capital fund

An investor invested Rs.50,000.00 in debt fund on April 10, 2013, & remain invested till March Feb. 2014. He is in the tax bracket of 10% for Financial Year 2013-14. Suppose Sunil received Rs. 5500.00 as the return from debt fund.  This income from debt fund will be added to his salary and will be taxed at 10% rate. So Rs.550 was the amount he had to pay as tax.

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Tax on Long-term capital fund

In the above example, had the amount of Rs.1,00,000.00 remained invested from April 10, 2011, to April  26, 2014. The return he earned from such investment was supposed Rs. 29000. Now this gain is considered as long-term capital gain and will be taxed at the rate of 20% with indexation benefit.

Taxation of dividend on debt funds

It is important to note that dividend received from debt fund is tax-free in the hands of a unit holder of the debt fund. On the other side, the company has to pay Dividend Distribution Tax (DDT) before distributing the dividend.  It should be noted that such DDT portion comes from NAV of units and hence after declaring dividend the NAV of the fund reduces.

What is considered as redemption

It is very important to note that whenever investor is making transaction wherein units of debt fund goes out from the holding is considered as redemption. So one has to be careful in cases of a switch over from growth option of dividend option or from one plan to another plan or changing plan from systematic withdrawal or transfer. All such transactions are considered as redemption and necessary taxation will be applied.


It is very simple and clear that taxation of mutual funds comes into the picture as and when units of mutual funds are sold. In the case of a debt fund, when units are sold within 3 years from the date of purchase; its gain is considered as short term capital gain and while units are sold after 3 years from purchase date is called long-term capital gain. Investors in the higher tax bracket are advisable to hold the units till 3 years because if the units are sold within 3 years then the tax rate will be applicable which is increase the outlay of tax. On the other hand investors with 10% to 20% tax bracket will not have the significant tax impact. Moreover, the dividend from debt fund is tax-free.

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