A debt mutual fund is a type of investment vehicle that pools money from several investors to invest in a portfolio of fixed income securities such as bonds, debentures, and government securities. The interest income generated by the underlying securities serves as the main source of income for these investments. Therefore, compared to equity mutual funds, long term capital gain on debt mutual fund are typically more steady and predictable.
The tax advantages that debt mutual funds provide are among their main benefits. In India, debt mutual fund long-term capital gains (LTCG) are taxed differently than short-term capital gains (STCG). We will go into great detail about the long-term capital gains tax on debt mutual funds in this article.
Long term capital gain tax on debt mutual fund
Long-term capital gains from debt mutual funds are subject to indexation and a 20% long-term capital gains tax in India. Three years or more of holding time is required for a debt mutual fund to be deemed long-term. Indexation is a technique that helps to lower the taxable gain by adjusting the asset’s purchase price for inflation.
For example, let’s say an investor purchased units of a debt mutual fund for Rs. 10,000 on 1st April 2018 and sold them for Rs. 15,000 on 1st April 2021. The investor’s long term capital gain on debt mutual fund would be calculated as follows:
Sale price – Purchase price = LTCG
Rs. 15,000 – Rs. 10,000 = Rs. 5,000
To calculate the indexed cost of acquisition, the cost inflation index (CII) for the year of purchase and the year of sale need to be considered. The CII is a measure of inflation released by the Central Board of Direct Taxes (CBDT) every year. The indexed cost of acquisition is calculated as follows:
Indexed cost of acquisition = Purchase price x (CII for the year of sale / CII for the year of purchase)
Assuming that the CII for the year of purchase was 272 and the CII for the year of sale was 317, the indexed cost of acquisition would be:
Indexed cost of acquisition = Rs. 10,000 x (317 / 272) = Rs. 11,625
The LTCG tax would be calculated as follows:
LTCG = Sale price – Indexed cost of acquisition
Rs. 15,000 – Rs. 11,625 = Rs. 3,375
LTCG tax = LTCG x 20%
Rs. 3,375 x 20% = Rs. 675
Therefore, the investor would have to pay a LTCG tax of Rs. 675 on the sale of units of the debt mutual fund.
The advantage of indexation
As seen in the example above, indexation helps to reduce the taxable gain and, as a result, the tax liability. This is because the indexed cost of acquisition is adjusted for inflation, which means that the purchase price is adjusted upwards to account for the rise in the cost of living. This reduces the overall gain and, as a result, the amount of tax payable.
Indexation helps to ensure that taxpayers are not penalized for holding an asset for a long period of time due to inflation, as the indexed cost of acquisition takes into account the effects of inflation on the value of the asset. This encourages long-term investment and reduces the tax burden on individuals and businesses.
The benefit of long term investment
Another advantage of investing in debt mutual funds is that the LTCG tax rate is lower than the STCG tax rate. The STCG tax rate on debt mutual funds is the same as the investor’s income tax slab rate. This means that if the investor falls in the highest income tax bracket, the STCG tax rate could be as high as 30%. Therefore, by holding onto the investment for a longer period, investors can benefit from a lower tax rate on their gains.
On the other hand, the tax rate on long term capital gain on debt mutual fund is 20% with indexation benefit. This means that investors can save a significant amount of money on taxes by holding onto their investment for more than three years. Overall, investing in debt mutual funds can be a tax-efficient way to earn returns on your investment.
Conclusion
Mutual fund investments in debt can be a desirable choice for investors seeking steady returns with less volatility than equity investments. Long-term investors may find long term capital gain on debt mutual fund to be a desirable option due to the tax advantages that come with them, such as the lower tax rate and the advantage of indexation.
Investors can benefit from a lower tax rate on their gains by keeping the investment for a longer period of time, which can help to increase their overall returns. To fully understand the tax ramifications of any investment, it is always advisable to speak with a tax professional or financial advisor.
