With the tax rules for debt mutual funds changing over the last two years, many investors stand curious about how the redemptions will also be taxed by the government. If you’re an investor who allocated sums in the old debt mutual funds on or before April 1, 2023, a query raised and responded to on Money Control’s ‘Ask Wallet Wise’ should instil some clarity.
In a query raised, an individual said, “I invested my retirement corpus in debt mutual funds in the financial year 2020–21. If I redeem them now, how will my tax liability be computed? At the time of investment, long-term capital gains (after three years) on debt mutual funds were taxed at 10 per cent, but the rules have since changed.” Balwant Jain, a Mumbai-based CA and CFP, advised how an individual can
proceed in such a case.
Redemption Treated As Long-Term Capital Gains
In an explanation, Jain pointed towards the law amendments issued pertaining to the 2023 Finance Act. According to which, if the equity investment in a mutual fund scheme does not exceed 35 per cent of the corpus, the fund is treated as a debt fund. The gains accrued are taxed as short-term capital gains regardless of the holding period at the applicable rates in the income tax slab.
The Finance Act, 2024, further tweaked the structure and established that a mutual fund scheme must have at least 65 per cent investment in debt instruments to be marked as a debt fund. The revised definition applies to redemption or sale transactions noted in the 2025-26 financial year.
But the good thing is that the law continues to provide benefits on investments made in debt mutual funds before April 1, 2023. The gains received from this investment are still treated as long-term capital gains. They are taxed at 12.5 per cent, with additional cess and surcharge applicable.
Since the concerned individual made their debt mutual fund investments before April 1, 2023, their redemption gains will be treated as long-term capital gains and be taxed at the rates mentioned with applicable charges.
Rebate
The long-term capital gains will continue to be taxed at 12.5 per cent irrespective of a person’s total income, if they opt for the new tax regime, since the rebate under Section 87A is not available against income taxed at special rates.
Under the old tax regime, an individual was eligible for a rebate of up to Rs 12,500 against overall tax liabilities if their total income did not exceed Rs 5 lakh. Exceptions were made for long-term capital gains from listed equity shares and equity-based mutual fund schemes.
