So, you are an investor who has made the smart decision to invest in debt mutual funds. You have researched, selected the right schemes, and are enjoying the benefits of steady returns on your investment. But one important factor you might have overlooked is your tax liability.
Debt mutual funds are an important element for any investment portfolio. Investing in fixed-income instruments, such as corporate debt securities, government bonds, and money market instruments, offers predictable returns with lower volatility.
Proper tax planning can help maximize your returns and minimize the tax outgo. However, like all investments, debt funds also attract taxes, and as an investor, you should know the tax liabilities and plan your investments accordingly. But to achieve that, you must first understand the critical factors determining your debt fund investment’s tax liability. Here is what you need to know.
 "How to determine your debt fund investments’ tax liability? 1")
Taxing dividends offered by debt funds
A major tax implication of investing in debt funds is the treatment of dividends. Debt funds were subject to a dividend distribution tax (DDT). But, from April 1, 2020, DDT has been abolished. This means that mutual fund dividends have been made taxable by investors. Any dividend income from your mutual funds will be considered income from other sources and taxed as per your applicable tax slab.
For example, if you fall in the 30% tax slab, you will have to pay Rs. 30 on every ₹100 dividends you receive from your mutual fund investments.
Changes to LTCG tax in Budget 2023
When you redeem your debt mutual fund schemes, it is considered a short-term capital gain or long-term capital gain, depending on the holding period. Till March 31, 2023, the holding period of your investments determines the tax liability on your debt fund investments. Debt investments held for over three years were given long-term capital gains (LTCG) benefits and taxed at a flat rate of 20% with an indexation benefit.
However, starting from April 1, 2023, those debt funds having less than 35% equity share will be treated as STCG (short-term capital gain), which means they will be taxed at your income tax slab level.
To put this into context, let’s assume that you fall under the 30% tax slab and have earned an LTCG of Rs. 60,000 from your debt fund investment (holding less than 35% equities). With the new policy coming into effect, you would be subject to a tax amount of Rs. 18,000 (30% of Rs. 60,000), along with surcharge and cess.
It is important to note that investments made in debt funds up to March 31, 2023, will benefit from the existing long-term capital gains taxation regime.
To wrap up
With a clear understanding of how taxes affect your debt fund investments, you can plan your finances better and maximize your returns while minimizing your tax liability.
Also, to ensure that your investments comply with the relevant tax laws and regulations, it would be wise to consult a financial advisor and a tax professional. With their right advice, guidance, and strategies, you can invest smartly in the best mutual funds and enjoy better returns while ensuring you keep your tax liabilities under check.
