Tax on Debt Mutual Funds

Tax on Debt Mutual Funds is something every investor thinks about when planning to invest in these schemes.

Debt funds are those mutual funds that have a debt exposure of more than 65 percent in their portfolio. If you were to redeem your debt fund units during a three-year holding period results in short-term capital gains. These profits are added to your taxable income and taxed at the rate set by your income tax bracket.

Long-term capital gains are realized when you sell debt fund units after a three-year holding period. After indexation, these profits are taxed at a flat rate of 20%. You will also be charged the relevant cess and surcharge on tax.

Let us understand how the tax on debt mutual funds works in the above-mentioned scenarios.

Short Term Capital Gains (STCG) Tax on Debt Mutual Funds

The tax on Debt Funds that are held for less than three years is determined according to the individual’s income tax bracket. Raj, for example, is a Marketing Manager who makes Rs.10,000,000.00 a year. He is taxed at a rate of 20%, according to the most recent tax slabs for the year 2016-17. Now, Raj has invested Rs.1,000,000 in an HDFC Debt Fund for a two-year term. But because this fund has been held for less than three years, the profits made on it will be classified as short-term capital gains tax on Mutual Funds and will be at the same rate as Raj’s income tax bracket, which is 20%.

If Raj got a return of Rs.10,000 on this debt fund, he would have to pay 20% of that amount as interest, which amounts to Rs.2000, according to his tax rate.

Long Term Capital Gains (LTCG) Tax on Debt Mutual Funds

Long-Term Capital Gain Tax on Mutual Funds includes any interest received on debt funds held for longer than three years. In this scenario, the appropriate tax rate is 20% after indexation and a 3% cess, bringing the total to 20.90 percent.

Raj again, for example, works in the Marketing Industry. He earns Rs.15,00,000 per year and has deposited Rs.2,00,000 in a debt fund for the past five years. His debt fund falls under the definition of long-term capital gains, and he is eligible for a tax deduction of 20% with indexation plus a 3% cess on the profits received, according to the newest tax rules.

Raj owes a total of 20.90 percent in taxes on the interest he earned on his debt fund.

What is Indexation?

Indexation is the process of taking inflation into account by using a price index that compensates for inflation. The change in inflation from the time you acquire your asset to the time you sell it is accounted for by indexations. The central tax authorities are the ones who publish the cost inflation index figure every year.

Indexation has no bearing on the calculation of tax on returns from debt funds held for less than three years. It is only taken into consideration when calculating the tax on returns from debt funds held for longer than three years.

There is no set time limit for investing in debt funds for the advantage of indexation; any holding term of three years or more would suffice. Your base or first financial year will be 2020-21 if you invest by 31 March 2021 and redeem by April 2024 or later. Your investment year will be 2021-22 if you invest in April 2021. This results in a one-year disparity in indexation benefit.

Are Debt Mutual Funds Tax Free?

No, Debt Mutual Funds are not Tax Free. However, the selling of debt fund units is exempt from the STT. The longer you keep your mutual fund units, the lower your tax bill will be. Long-term capital gains are taxed at a lower rate than short-term capital gains.


Kar, Mili, and Parag Shil. “DEBT mutual funds–An overview in Indian Scenario.” ZENITH International Journal of Multidisciplinary Research 2.8 (2012): 422-432.

Goel, Archana. “A Comparative Study on Performance Analysis of Debt and Equity Schemes at HDFC Mutual Funds with Reference to Birla Sun Life and ICICI Prudential Debt and Equity Mutual Funds.” International Journal of innovative research and development 4.4 (2015).


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