Central Government passed the Amendments to the Finance Bill, 2023 in Lok Sabha on 25th March 2023.
As per the amendment, the Long-Term Capital Gains are removed for Debt Mutual Fund Schemes including Gold Mutual funds, Fund of Funds, Conservative Hybrid Mutual Funds & Foreign Equity Mutual Funds.
This amendment is applicable for investments made from 1st April 2023 & for those Debt Mutuals Funds whose Equity Investment in such fund does not exceed 35%.
Table of Contents:
- No TDS IN Debt Funds
- SIP Investment Option in Debt Funds
- Setting off the losses
- Liquidity & Partial Withdrawal available in Debt Mutual Funds
- SWP for Regular Cash Inflow in Debt Funds
- Tax deferment in Debt Mutual Funds
What are Debt Mutual Funds?
Debt Funds invest in Fixed Income Instruments such as Corporate bonds, Government bonds, Treasury bills, Debentures, etc.
Since they earn a fixed return, they are less risky than Equity Mutual Funds. Also, it provides higher capitalization than Fixed Deposits.
Old Taxation of Debt Mutual Funds
Earlier Debt Mutual Funds are more Tax Efficient than traditional Investment Options like Bank FDs.
Short-Term Capital Gain – If Debt Mutual Fund is sold before 3 years, the gains are taxed as per Investor’s Slab Rate.
Long-term Capital Gain – if the units are redeemed after 3 years, a 20% tax will be applicable on the gains along with the indexation benefit.
From 1st April 2023, the Debt Mutual Fund Schemes will be taxed at Income Tax Rates applicable to your income irrespective of the holding period.
Investments made till 31st March 2023 can enjoy the existing indexation benefit if held for more than 3 years.
If you have any SIPs in Debt Mutual Fund Schemes, only investments made till March 2023 will enjoy the indexation benefit. SIPs made from April can’t enjoy this LTCG indexation benefit.
Let us understand how it affects your tax outgo with an example scenario.
Let us assume, you have invested Rs. 5 Lakhs in a Debt Mutual Fund Scheme in March 2020 & it gave you a 7% return per annum. Now the fund value would be Rs. 6.12 Lakhs.
Assumptions for Analysis:
|Return on Investment||7%|
|Cost Inflation Index (CII)|
Let us look at the table below to clearly understand how the above metrics will be calculated between the old and new taxation methods.
|Old taxation||New taxation|
|Cost of purchase (After Indexation)||5,72,664||Cost of purchase||5,00,000|
|Tax payable on LTCG (20%)||7,971||Tax payable on LTCG (Assuming Highest slab rate – 30%)||33,756|
|Post-tax Maturity Value||6,04,550||Post-tax Maturity Value||5,78,765|
|Post-tax Return||6.53%||Post-tax Return||5.00%|
If you redeem your Debt Mutual Fund after 3 years in March 2023, earlier after the indexation benefit, the tax payable on LTCG is ₹ 7,971.
Let us assume the same scenario where the indexation benefit is removed. Then, you need to pay a tax of ₹ 33,756 (in the highest tax bracket). Almost 4 times higher than the above case.
The Way Forward in Choosing your Investments
Taxation shouldn’t be your only criterion in selecting an Investment Avenue. An investor should consider all other factors like liquidity, risk-adjusted return & other benefits before taking an investment decision. Do not just focus on the propaganda distributed by the media that the Removal of Indexation in Debt Mutual Funds has made it on par with FDs.
Many other factors make the Debt Mutual Fund have an upper hand over Bank FDs. As an investor, going forward, Debt Mutual Fund could be a better option than Bank FD due to the following reasons:
1.No TDS in Debt Funds
There is no TDS in Debt Mutual Funds. In Bank FDs, if the interest income exceeds ₹40,000 (Senior citizen – ₹ 50,000) in a year then the bank deducts 10% TDS on Interest.
One must submit Form 15 G & Form 15 H – if your taxable income is below the limit so that the banks won’t deduct TDS.
2. SIP Investment Option in Debt Funds
Generally, investors allow their surplus funds to accumulate in their saving account which makes your money lie idle when it could be producing returns. And then with a lumpsum amount, they open an FD.
But in Debt Mutual Funds, you have the Systematic Investment Plan (SIP), or even with the irregular surplus you can invest.
3. Setting off the losses
The capital gains from the Debt Mutual Funds can be set off against the capital losses you made from Stocks or other investments. This set-off advantage is missing in your FD investments.
4. Liquidity & Partial Withdrawal available in Debt Mutual Funds
Debt Mutual Funds are very liquid. Your redemption request is executed within one day.
Also, you can withdraw as much as you want. But in FD, you have to break your deposit, even if you need a lesser amount.
5. SWP for Regular Cash Inflow in Debt Funds
A Systematic Withdrawal Plan (SWP) facilitates the investor to withdraw money at periodic intervals. While your Debt Fund grows at a pace, you just redeem a certain amount regularly to meet your Financial Needs.
6. Tax deferment in Debt Mutual Funds
Interest income from FD is taxed every year under the head Income from Other Source. In Debt Mutual funds the tax is deferred until you redeem your units. i.e., as long you hold the fund, you need not pay tax. Only at the time of redemption, the capital gain is calculated & taxed.
Let us consider two scenarios for your Investment Options
Scenario 1: You invest 1 lakh under Bank FD & Debt Mutual Fund. After 3 years your FD matures and also at the same time you redeem your Debt Mutual funds fully.
Scenario 2: You invest 5 lakhs under Bank FD & Debt Mutual Fund. Each year you are in need of Rs. 50,000. The FD matures after 3 years as scheduled but you can redeem the required amount under a Debt Mutual fund.
The taxation under each scenario is explained below.
Let us calculate What your Final Maturity Value is under the 1st scenario.
|Debt Funds / Hybrid Debt Funds vs Fixed Deposit|
|Scheme: – ICICI Pru Medium Term Bond Dir Gr|
|Start Date: – 27-03-2020|
|End Date: – 27-03-2023|
|Category: – Debt: Medium Duration|
|AMC: – ICICI Prudential Mutual Fund|
|Income Tax Rate: – 30|
|Pre-Tax Return||Investment Amount||Redeemed / Maturity Amount||Total Interest / Profit Amount||Annual Interest / Return (%)|
|ICICI Pru Medium Term Bond Fund||100000||122498||22498||7|
|Post Tax Return||Pre-tax Interest / Profit Amount||Capital Gains Tax||Indexed Amount||Income / Capital Gains Tax||Post Tax Interest / Profit Amount|
|Fixed Deposit||20448||Not Applicable||Not Applicable||6134||14314|
|ICICI Pru Medium Term Bond Fund||22498.08||Short Term||Not Applicable||6749||15749|
The Fixed deposit interest rate is based on historical State Bank of India Fixed deposit rates for different deposit terms. You can also calculate on your own here
The post-tax maturity value in FD would be ₹ 1,14,314 & in Debt Mutual Funds it would be ₹ 1,15,749.
Scenario 2: You invest 5 lakhs under Bank FD & Debt Mutual Fund. The interest on the Fixed deposit is received on yearly basis (non-cumulative). Similarly, the same amount is withdrawn from the Mutual fund scheme every year. Let us compare the tax outgo in FD with Mutual funds.
|Interest Income (per year)||₹ 35,000|
|Maturity Value||₹ 5,00,000|
|Tax outgo (every year)|
|Taxable interest Income||₹ 35,000|
|Tax payable on Interest income||₹10,500|
|Debt Mutual fund||UNITS||NAV||AMOUNT|
|After 1 year|
|Tax Payable on Gains||₹ 687|
|After 2 years|
|Tax Payable on Gains||₹ 1,329|
|After 3 years|
|Tax Payable on Gains||₹ 1,929|
Since it is a non-cumulative FD, every year you receive an interest income of ₹ 35,000. This is added to total taxable income & taxed as per your slab rate. The tax outgo would be approximately ₹10,500 per year (Assuming you are in the highest slab rate).
Under Mutual funds, only proportionate units are withdrawn from the fund & without disturbing the rest of the fund. The capital gains arising out of the sale have to be paid in the financial year & not for the overall returns. Out of ₹ 35,000 only ₹ 2,290 is your gain & it is taxed at your slab rate. The tax outgo here would be ₹ 687 (Assuming you are in the highest slab rate). Similarly, whenever you redeem your units, the tax has to be paid for the respective units in the respective financial year.
When you compare the tax outgo, under FD it is ₹ 10,500 every year. Whereas in Mutual funds the tax outgo would be ₹ 687, ₹1329 & ₹ 1929 in the first 3 years respectively.
The concession given to Debt Mutual Fund is taken away. That does not mean that the total sheen is lost. The tax outgo from your side is only when you redeem your units, so till then tax payment is deferred.
If you are considering corpus accumulation for any of your Short-Term Financial Goals like a Down payment for a Home etc. through your monthly surplus, then Debt Mutual Funds could be considered a better choice among the other debt instruments available in the market.
Pick your Investments considering its
- Risk-Adjusted Return
- Personal Risk Appetite
Don’t fall into pitfalls just to save tax. As an investor, you should be focusing on building a diversified portfolio to meet your financial goals.
You can always consult with a Professional Financial Advisor to customize your Financial Plan with appropriate Investments suitable for your Investment Portfolio.