1. For long debt mutual funds have been an instrument for effectively managing tax liabilities. Debt funds even though being of similar nature to fixed deposits were more tax efficient, but on and from 1st April 2023 much of these benefits have been taken away.
2. In the erstwhile regime, taxpayers had the following benefits-
a. While interest received on FD where taxed every year at slab rates applicable to the assessee, debt mutual funds get taxed only at the time of its redemption that too after indexation in the case of long-term capital assets at the rate of 20%.
b. Even if the assessee followed the cash system instead of the mercantile system in accordance with section 145 for offering the interest income to tax, they had to go through the tedious process of carrying forward the TDS deducted during the year to the next financial year and ultimately flaming it in the year in which the interest income is ultimately received. In addition to this TDS being deducted every year hampers the process of compounding, even if tax is paid in the year of receipt still since 10% of interest income is already deducted on account of TDS the same could not be reinvested to provide a compounding effect.
3. With this amendment, the government has tried to bring debt mutual funds at par with fixed deposits. On account of the amendments brought in through the finance act 2023 specified debt mutual funds shall no longer be allowed the benefit of indexation. In addition to that the gain arising on redemption shall be text according to the individual slab rate applicable to the assessee. So for example, if one had invested rupees 2 lakhs in a date mutual fund redeemable after 5 years for a maturity amount of let`s say 3 lakh rupees there arises again of rupees 1 lakh off course without indexation and the same shall be text according to the slab rate applicable to the assessee.
4. The amendment taking away the benefit of indexation and imposing a tax on the basis of slab rate shall only apply to specified debt mutual funds. Specify debt mutual fund has been defined as debt mutual funds where the equity portion of the mutual fund scheme does not exceed 35%. Apart from this, indexation benefits will not be available in the case of LTCG on gold mutual funds, international equity mutual funds, fund of funds, and hybrid mutual funds as well.
Specified Debt MF (as stated above)
Head of Income
Rate of Tax
LTCG-10% (only above 1 lakh) without indexation
STCG only – Slab Rate
STCG- Slab Rate
LTCG 20% with indexation
In accordance with the option opted u/s 145 i.e. cash or mercantile system
At the time of redemption
“Gain on sale of Mutual Funds be it equity or debt-based can also be taxed under the PGBP if the said investments can be said to be made for the purpose of business and in which case it shall only be taxed according to the slab rate applicable to the assessee.
5. Yes, it is true that the government has taken away a very good portion of the benefit available with debt mutual funds but there still exists a not so talked about benefit of investing in interest-bearing securities through mutual funds and that is the interest which the mutual fund house receives every year on their investments are tax-free in the hand of mutual funds and we get the benefit of increased NAV without paying any tax on yearly interest earned by the mutual fund house. Unlike FDs in which case TDS is deducted at the rate of 10% every year which hampers the process of compounding, interest received by mutual funds does not get taxed at the time of receipt and point of taxation arises only when those units of mutual funds are either redeemed or are sold in the secondary market.
6. However the aforementioned shall apply only to mutual funds purchased on and from the 1st of April 2023 and nothing mentioned above shall have any effect on the taxation of MFs purchased earlier.
CA Pranay Jain is a young and aspiring Chartered Accountant. He qualified Chartered Accountancy Course in 2021 and has a well-established practice in various fields of taxation and auditing, with his core area of practice being in the field of litigation i.e., handling assessment and appeal-related matters and representing assesses before various tax departments.
He is also socially active on LinkedIn at linkedin.com/in/capranayjain
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