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Taxation on Debt mutual funds

Written by - Marisha Bhatt

March 27, 2023 6 minutes

We have all heard from various investment advisors and numerous investment articles on the internet that mutual funds are an essential investment vehicle to meet financial goals in a flexible yet timely manner. Debt mutual funds, especially, are very lucrative investment options for risk-averse investors who form a vast majority in a country like India. The latest changes in taxation however are bound to affect these investors who may no longer find debt mutual funds as attractive. 

Given here is detailed information on debt mutual funds and the latest changes in taxation affecting them.

Read More: How debt mutual funds work?

What are debt mutual funds?

Debt mutual funds are mutual funds that invest predominantly in debt instruments that provide fixed-income instruments like government securities, corporate and government bonds, money market instruments, etc. The primary focus of these mutual funds is to provide more or less stable returns to the investors as theta re considered to be low-risk investment options as compared to equity mutual funds or hybrid funds that invest predominantly in equities. These funds are therefore the preferred choice of investment for risk-averse investors or investors who are looking for stable passive income. 

What are the changes in the taxation of debt mutual funds?

As per the provisions of the Income Tax Act, 1961, the gains from the sale of debt mutual funds are considered to be short-term capital gains (STCG) when the fund is sold after a holding period of less than 36 months while capital gains on the sale of debt funds held for a period of more than 36 months are considered to be long-term capital gains (LTCG). STCG on debt funds is taxed as per the applicable slab rates of the investor whereas LTCG is taxed at a flat rate of 20% after the benefit of indexation or 10% without indexation. 

The Finance Minister on 24th March 2023, announced an amendment to the Budget 2023 in the capital gains tax on debt funds. As per this amendment, LTCG on debt mutual funds will no longer have the benefit of indexation. This amendment will be applicable from 1st April 2023 and as per industry experts, this move has inadvertently created three categories of mutual funds with respect to taxation. These categories include

  • Equity mutual funds that invest a minimum of 65% of the fund in equity and equity-related instruments
  • Mutual funds schemes that do not invest more than 35% of the fund in equities will be taxed as per STCG.
  • Debt mutual funds that invest more than 35% but less than 65% of equity will still be eligible for indexation as per the rules applicable to date, i.e, taxable at 20% with the benefit of indexation.

Therefore, investors who wish to invest in pure debt mutual funds at the same time receive the indexation benefit on LTCG can invest in such funds before 31st March 2023 and continue to avail of the benefit. 

Watch this video for a detailed understanding of what changes for debt mutual fund investors

What is the impact of the proposed changes?

The recent changes have sent a shock wave across the debt market and especially for retail investors. Experts believe that this move will crash the debt market in the country as the returns will no longer be as attractive for the common investors. This move will bring the returns from debt mutual funds at par with the bank FDs

Many believe that this will provide a push for the bank deposits that have not risen as much as the credit demand in the past 12 months. Investors will likely prefer the less risky investment options like fixed deposits as there will be no tax arbitrage and this may lead to less inflow of funds towards debt mutual funds. These funds will therefore have to rely purely on their ability to provide better risk-adjusted returns to attract investors and make investments in debt mutual funds lucrative. 

However, it is important for investors to note that inspite of the changes in tax rules, debt mutual funds may still prove to be beneficial to investors for these reasons

  • Unlike Fixed Deposits where interest is taxed on accrual basis, on debt mutual funds the gains are taxed only when they are redeemed. 
  • Tax is deducted at source on FDs when the interest payable exceeds Rs 40,000 from all the FDs at a single bank, there is no TDS applicable on Debt mutual funds irrespective of the amount of gains.
  • Debt mutual funds may allow better rates of compounding in comparison to FDs.

Many mutual fund houses like Edelweiss Mutual Fund are urging the government to reconsider this proposal for change in the taxation of debt mutual funds as they believe tax incentives can be instrumental in strengthening the bond market in the country. This move will also make it difficult for financial planners to create a portfolio of safer investment options that meet is instrumental in providing a sufficient retirement corpus and retirement benefits. 

Equity funds, especially hybrid funds may see a higher inflow of funds as they will provide the roundabout benefit of better risk-adjusted returns and taxation with indexation benefits for the investors. There is also a countering view that although there will be some shift from debt mutual funds to fixed deposits, the move will not have a dramatic impact on debt mutual funds as many fund managers believe taxation is not given as much priority in deciding the asset allocation


The proposed changes in the taxation of debt mutual funds will be tolled into effect from 1st April 2023 and which will bring them in line with FDs and NCDs. The corporate bond market may gain from the proposed but mutual funds houses focusing on fixed-income mutual funds may face a negative impact. Investors, however, have the chance to continue to reap the benefits of indexation by investing in debt mutual funds before 31st March 2023.


1. Who are the target investors for debt mutual funds?

The target investors of derby mutual funds are risk-averse investors and investors like retirees looking for fixed and stable income sources.

2. Is the proposed amendment applicable only to debt funds?

No. The proposed amendment is applicable to debt mutual funds having investment in equity up to 35%, and other assets like gold mutual funds, international equity, and domestic FoFs.

3. What are the types of debt mutual funds in India?

The different types of debt mutual funds available in India are liquid funds, ultra-short Duration Funds, low duration funds, medium duration Funds, fixed maturity plans, gilt funds, dynamic bond funds, and more.

4. What are the features of debt mutual funds?

Some of the features of debt mutual funds include low risk, fixed and stable returns, liquidity, diversification, lower expense ratio as compared to equity funds, an option to choose a suitable type of debt fund based on the investment horizon, etc.

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