Debt Mutual Funds - New Tax Rules - What to Do Next?

Debt mutual funds are a popular investment option for those looking to invest in debt. However, find how the recent changes in taxation will affect it.

Debt Mutual Funds - New Tax Rules - What to Do Next?

Impact of Regulations

In the past few years, you must have invested in debt mutual funds, enjoying their potential for stable returns and lower risk than equity investments. But now, with the introduction of the new tax rules applicable from April 1, 2023, things are shifting.

The taxation of debt mutual funds, which used to have the benefit of indexation to lower tax liability on long-term gains, has been altered. So, read this article to stay in the loop and understand the new tax rules and how they can affect you as an investor.

What are Debt Mutual Funds?

Debt mutual funds are like a collective pool of money managed by professionals, but instead of investing in stocks, they invest in various fixed-income securities. These include government and corporate bonds and other low-risk, interest-bearing investments.

The returns from debt mutual funds typically come from the interest earned on these investments. It's a way for individuals to invest in bonds and similar assets without directly buying them themselves.

What are the Existing Mutual Fund Tax Rules?

Before the recent amendment, debt mutual funds were taxable in accordance with indexation and holding period rules.

  • Short-Term Debt Mutual Fund: The gains on debt mutual fund units can be considered short-term capital gains upon redemption before the completion of 36 months (three years). Capital gains on short-term investments are taxed at your standard income tax rate.
  • Long-Term Debt Mutual Funds: A long-term capital gain (LTCG) is when a gain exceeds 36 months. Over an extended period, capital gains are subject to an indexation tax of 20%. This means that investors' profits have been adjusted for inflation, reducing their investment tax obligations.

Taxation on Debt Mutual Funds After April 1, 2023

According to the latest debt mutual funds news, the debt mutual fund taxation will apply to the following categories:

  • An equity-oriented scheme must invest a minimum of 65% in equity
  • The gains on the sale of mutual fund schemes with less than 35% equity are classified as short-term capital gains.
  • Equity schemes with a shareholding above 35% but below 65% will qualify for indexation and taxation at 20%.

Thus, debt mutual funds will no longer be eligible for cost indexation and long-term tax benefits.

From April 1, 2023, debt mutual funds with more than 35% equity investments will modify their tax structure to ensure that short-term capital gains are considered short-term capital gains and are taxed accordingly. Until March 31, 2023, investments will benefit from lower long-term debt fund taxation at 20% and indexation.

How Will the Changes In Tax Rules Affect the Taxation on Debt Mutual Funds?

The following are some of how the change will affect investors:

  • According to financial experts, this proposal will provide the same tax implications for bank savings plans as debt mutual funds, boosting bank savings plans.
  • It may affect investments in corporate bonds held by debt mutual funds.
  • There are many investment instruments to choose from instead of long-term debt mutual funds, such as equity funds, non-convertible bonds, bank fixed deposits, and other debt instruments.
  • In the new tax rule, short-term debt mutual funds (less than three years) will not be subject to taxation for corporations and high-net-worth individuals (HNIs).

Further, experts recommend investing in debt mutual funds for a higher rate of return over the long term.

Debt Mutual Funds Taxation Before April 1, 2023

Capital gain tax on debt mutual funds is taxed by the period investors held them. Generally, short-term capital gains (STCG) are considered capital gains reported three years after purchase. An investment redeemed after three years or more is termed long-term capital gains (LTCG).

The following is how these gains were taxed before the Finance Act of 2023:

Type of Mutual Fund: Debt Mutual Funds

  • STCG Tax: Investors are taxed based on their tax slabs; gain is added to their taxable income.
  • LTCG Tax: 20% (plus applicable surcharges and cess) with indexation.


During FY2016-17, Rahul pumped 1 lakh into a debt mutual fund and withdrew it in FY2022-23. Due to the longer holding period, the gains are taxable as LTCG. Let's say the sale was 150,000. Taxes on gains were as follows:


Financial Year











Indexed Investment cost





Tax Payable



Debt Mutual Funds Taxation After April 1, 2023

As of April 1, 2023, debt fund investments no longer qualify for the indexation benefit on LTCG. The investor's gains will instead be taxed as part of their taxable income. As of April 1, 2023, regardless of how long debt fund units were held, any gains on acquired units from that time forward will be deemed STCG. LTCG indexation benefits continue for units of debt mutual funds purchased before April 1, 2023, but sold after that date.

As of April 1, 2023, the following rules will apply to debt mutual funds:

  • Type of Mutual Fund: Debt Mutual Funds
  • STCG Tax: Gains are taxable income for the investor and are taxed accordingly.


Let's take the example of Rahul, who invested one lakh in a debt mutual fund during the fiscal year 2023-24 and redeemed it in the fiscal year 2028-29 at a sale value of Rs. 1.5 lakhs. Under the new tax rules, gains will be taxed in the following manner:




Amount (Rs.)












Tax Payable 

15,000 (30% tax bracket)

10,000 (20% tax bracket)

5,000 (10% tax bracket)

Should You Invest In Debt Mutual Funds?

Experts say that Hybrid funds with more than 35% investment in equities will offer tax advantages for many years. Interest in other categories, such as Dynamic Bonds, Multi Assets, and Equity Savings, is expected to increase.

You can still invest in these hybrid debt funds if you are comfortable with a mix of equity in your debt investments. These funds offer an attractive combination of tax efficiency and performance.

Apart from the favourable debt mutual funds tax treatment, they still have several advantages over bank FDs. The following are some of them:

  • Flexibility In Partial Withdrawals

If you withdraw money from a bank FD partially, the interest rate will be reduced, but you will also be penalised. Debt funds don't pose such a problem. Liquidation of your investment may be made at any time at the fund's NAV. There will be no penalty or loss on your returns. So, in the case of debt mutual funds vs. Fixed deposits, debt mutual funds win.

  • Accruals Are Tax-Free

The entire interest accrued in a Bank FD is taxable, regardless of whether it is used. There is also a TDS on it. Investing in debt mutual funds is different. During redemption and realisation of gains, you will only be liable for tax on the profits from these funds.

  • Suitable For Generating Post-Retirement Income

It is still possible to generate post-retirement income from debt funds in a tax-effective manner compared to bank fixed deposits. Strategies for generating income after retirement still fall into the first and second buckets.

Regardless of new tax rules, investing in debt mutual funds, FDs, or any other investment vehicle ultimately comes down to each individual's goals and interests.

Bottom Line

Debt Mutual Funds have seen significant changes since the new tax rules were enacted. As an investor, being proactive and well-informed is crucial in adapting to these alterations effectively. If you stay up-to-date, get advice if needed, and look for tax-saving strategies, you can make better returns with these debt mutual funds.