There have been significant changes in the taxation of debt mutual funds.
Tax rules for debt mutual funds have changed sharply over the past two years, leaving many investors confused about how redemptions will be taxed. Today’s Ask Wallet Wise query decodes what are the tax rules if you invested before April 1, 2023.Ask Wallet-Wise initiative offers expert advice on matters related to personal finance and money-related queries. You can email your queries to askwalletwise@nw18.com, and we will try and get a top financial expert to address your queries.
I invested my retirement corpus in debt mutual funds in the financial year 2020–21. If I redeem them now, how will my tax liability be computed? At the time of investment, long-term capital gains (after three years) on debt mutual funds were taxed at 10%, but the rules have since changed.
Expert’s Advice: There have been significant changes in the taxation of debt mutual funds. The Finance Act, 2023 amended the law to provide that if the equity investment in a mutual fund scheme does not exceed 35% of the corpus, the fund is treated as a debt fund, and any gains are taxed as short-term capital gains, irrespective of the holding period. Such gains are taxed at the applicable income tax slab rate.
The Finance Act, 2024 further refined the definition by stating that a mutual fund scheme must have at least 65% investment in debt instruments to qualify as a debt fund. This revised definition applies to redemption or sale transactions made in the financial year 2025–26 and onwards.
However, the law provides a grandfathering benefit for investments made in debt mutual funds prior to April 1, 2023. Gains from such investments continue to be treated as long-term capital gains and are taxed at a flat rate of 12.5%, plus applicable cess and surcharge.
Since you invested in debt mutual funds before April 1, 2023, the gains on redemption will be treated as long-term capital gains and taxed at 12.5%, plus cess and applicable surcharge.
If you opt for the new tax regime, the long-term capital gains will continue to be taxed at 12.5%, irrespective of your total income, as the rebate under Section 87A is not available against income taxed at special rates.
Under the old tax regime, if your total income (including both normal income and special rate income) does not exceed Rs 5 lakh, you will be eligible for a rebate of up to Rs 12,500 against your overall tax liability, except for long-term capital gains arising from listed equity shares and equity-oriented mutual fund schemes.
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