Bonds, debentures, and other fixed income securities, as well as other debt instruments make up the majority of the investments made by Debt Mutual Funds. Before going into the changes understanding debt mutual funds and their current tax structure is crucial. It is very important to understand how taxation can impact our gains after considering different modes of duration, tax rates etc.
The holding period is regarded as a crucial component in determining whether the gain from the sale of those securities is a long-term or short-term capital gain. When making an investment in these securities, the investor should also take into account a number of different aspects.
In the below article we have made an effort to explain how debt mutual funds work, how are they different from fixed deposits and different types of tax structure applicable to them.
1. What is Debt Mutual Funds?
Ans. The word “debt” itself denotes the owing of funds from various sources for various economic endeavors. Debt mutual funds, primarily deal with fixed income securities, whereby investors invest in a specific fund in order to receive a fixed income over time in accordance with the conditions and agreements set forth by the parties.
2. How debt funds are different from fixed deposits?
Ans.
| FIXED DEPOSITS | DEBT FUNDS |
| (i) Rate of interest is between 5% to 8% | (i) Returns from Debt Mutual fund ranges between 7% to 9% |
| (ii) Withdrawal before maturity can be made by paying a certain amount as penalty | (ii) With or without an exit load, premature withdrawal is allowed. |
| (iii) Higher rate of safety | (iii) Safety rate depends on market fluctuations |
| (iv) Considered as an extra income and added to the total income of Assessee | (iv) In case of debt fund returns are considered as a capital gain depending on the period of holding |
3. Which factors must an investor take into account when making an investment in a debt mutual fund?
Ans.
- Risk & Returns analysis: It is crucial to evaluate the risk and return potential of debt mutual funds. Making wise investment decisions requires carefully weighing variables like credit risk, interest rate risk, and liquidity risk.
- Tax Implications: Investment in debt mutual funds carries certain tax implications that should be understood. The calculation of post-tax returns is heavily influenced by variables like capital gains tax and indexation benefit.
- Expense ratio & Fees: When assessing the effect on overall returns, it is imperative to take into account the expense ratio and fees related to debt mutual funds. It’s critical to evaluate these expenses for various funds.
A detailed understanding of a number of topics is necessary when investing in debt mutual funds, including fund types, risk and return analysis, tax implications, and expense ratios. A well-diversified investment portfolio can result from making well-informed decisions
4. How tax rates differ in case of Bonds, Debt Mutual Funds, Debentures?
Ans.
- Bonds:
Listed Bonds: Bonds that are listed on an approved stock exchange are subject to 10 % tax without indexation benefit in case there is long term capital gain & slab rates will be applicable for short term capital gain, which varies based on how long the bond is held. Bonds will be classified as short-term capital gains if they are held for less than 12 months, and as long-term capital gains if they are held for more than 12 months.
Unlisted Bonds: For bonds that are unlisted they will be considered as short term if held for less than 36 months, and gains shall be taxable as per the slab rates. For all unlisted held for more than 36 months shall be taxed at the rate of 20% without indexation benefit and will be treated as long term capital assets.
- Debt Mutual Funds:
In case of Debt Mutual Fund if the debt mutual fund is sold within a period of 36 month it will be classified as short-term capital gain or if the debt mutual fund is sold after 36 month it will be classified as long-term capital gain with indexation benefit but after amendment under Finance Act 2023 indexation benefit will no longer be available. Debt-investing mutual funds will now be taxed at corresponding slab rates for both short term as well as long term.
- Debentures:
Listed Debentures: Market Linked Debentures are a type of publicly traded security. They will be taxed as short-term capital asset in all cases and taxed as per the normal rates applicable to the Taxpayers without any indexation benefits.
Unlisted Debentures: Debentures that are not listed are taxed at 20% without indexation if held for more than 36 months, or at taxpayers’ slab rates if held for less than 36 months.
Hence it is important to consider the taxation outflow before making any type of redemption of units and definitely a consultation from Professional should be considered.
The above article is written by Mr. Mihir Verma ([email protected]) and reviewed by Mr. Suyash Tripathi ([email protected])
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