Debt mutual funds Taxation Changed. What should you do?

Debt mutual funds taxation was amended through the Finance Bill 2023. This removed the Long Term Capital Gains tax benefit. Debt mutual funds are a popular investment option for many investors who want to earn better returns than fixed deposits and save tax on their capital gains. However, the government, through the amendments has removed indexation benefits from debt mutual funds.  

What are debt mutual funds?

Debt funds are mutual funds wherein the underlying investments are held in fixed income instruments. They are mainly differentiated by the maturity term and the type of underlying instruments held in the portfolio of the mutual fund.

They strive to provide regular income along with scope of capital appreciation by investing in fixed interest generating instruments like treasury bills, government bonds, quasi-government bonds issues by institutions like railways, PSU banks, etc., corporate bonds, money market instruments among others.

Mutual funds that invest in highly rated instruments and that invest in short maturity instruments have less volatility and carry low risk. But those funds that invest in long term bonds with lower ratings carry higher volatility and risk. You can read about the different types of mutual funds here.

Debt Mutual Fund Taxation | What is the change in tax laws?

Debt Mutual Funds

According to amendments in Budget 2023, the debt mutual funds taxation will now be at the individual’s tax slabs. As per these amendments, no benefit of indexation for the calculation of long term capital gains on debt mutual funds will be available for investments made on or after April 1, 2023. However, only those debt mutual funds (click here to read about the different types of debt mutual funds) will lose this benefit where equity investments in such mutual funds do not exceed 35%.

This means that mutual funds that invest less than 35% in equities will be taxed at income tax rates applicable to your income slab, regardless of the holding period. This brings taxation parity between 100% debt mutual fund schemes and bank fixed deposits.

There are different types of debt mutual funds. If you invest in mutual funds that invest more than 35% in equities (such as hybrid or balanced funds), you will still get the long-term capital gains tax benefit at 10% without indexation or 20% with indexation if you hold them for more than one year.

How will the change in debt mutual funds taxation affect your existing investments?

The change in the debt mutual fund taxation will be applicable to units acquired on or after 1st April 2023. This can be inferred as no impact on existing investments and investments made until 31st March 2023 as they will continue to enjoy the long-term capital gains tax benefit with indexation if they are held for more than three years.

However, if you invest in such funds on or after April 1, 2023, you will have to pay tax at your income tax slab rate on your gains, regardless of the holding period. This will apply only to those debt mutual funds that invest less than or equal to 35% in equity shares. Therefore, you may want to review your investment strategy and goals before investing in these mutual funds after April 1, 2023.

What does not change?

While there is no doubt that one of the major advantage has been taken away, the below benefits of investing in debt mutual funds continue,

Defer taxation on capital gains.

When investors opt for growth option under debt funds, they do not have to pay taxes on the interest income earned by the fund until they redeem their units. In this way, investors can defer paying taxes on the growth and hence the returns through compounding. Compare this to a bank FD where the interest income earned by investor is added to the taxable income and taxed in the same financial year.

Set-off of capital gains losses against gains.

The returns generated from mutual funds are categorized as capital gains. And the capital gains rules allow losses from one source of capital assets to be set-off against gains from other capital assets. Investors can still use these to optimize their tax payments. While the benefits of long term capital gains have been taken away, investors can still set-off short term capital gains/losses.

A portfolio of debt instruments

A portfolio of debt instruments that are professionally managed by skilled analysts having experience in building a debt portfolio comprising various bonds, certificate of deposits, T-bills, etc that takes into consideration various risks such as credit risk, interest rate risk and liquidity risk.


Debt funds can be easily redeemed and withdrawn as per your requirement. Unlike fixed deposits that have mandatory lock-in periods and penalty for premature withdrawal, these mutual funds do not have such restrictions. Do note that some funds have an exit charge if investors redeem their funds before a stipulated time period.

Should you invest in Debt Mutual Funds?

While the change in debt mutual funds taxation has changed and the benefit of long term capital gains tax has been revoked, what has not changed is how the returns from these instruments get categorized. The returns from these are categorized as capital gains and not interest income. With that they have the following benefits

  • The returns are taxed only when you liquidate your holdings. Unlike bank FDs where the returns are taxed as interest income every year. Hence you get to defer your taxes.
  • Since the returns are not taxed every year, the compounding benefits are much better.
  • As debt mutual funds are taxed like capital assets, capital losses if any can be carried forwards and set-off against capital gains.

Before you move ahead with investing in debt mutual funds, thoroughly understand the risks associated with them, talk to a SEBI Registered Investment Advisor to understand your asset allocation and invest in them to meet your goals.


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