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Example for tax calculation in debt mutual funds

I am looking to move my FDs to debt mutual funds. My advisor is saying that they provide better returns and are more tax efficient. Can someone give me example how tax is calculated on debt mutual funds?

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Pijush Kanti Biswas

Both fixed deposits (FDs) and debt mutual funds are low-risk investment financial instruments and were used to be seen as comparable investment options. But recently major Indian banks, in both public and private sector, have revised the interest rates they offer on FDs. Country’s largest lender, State Bank of India (SBI), cut its interest rate on FDs to 6.90% for maturity period of 1-year and to 6.50% for maturity periods between 3 to 10 years, which is lowest in the industry now. In such a scenario, parking your cash in debt mutual funds is a wise investment.

The only concern remains now, is to understand the tax implication on these funds and how to calculate it. Let take an example to understand how tax implication works.

Say Ravi investing an amount of INR 10 lacs in debt mutual funds by Groww with around 10% returns annually.

First, decide the investment period in the funds, i.e. the difference between start/purchase date and selling date of units. Taxes upon debt mutual funds are of two types depending upon the period for which they are held.

These two types are:

1.  Short-term Capital Gain tax:

This is applicable on debt mutual funds held for a period of 36 months or less i.e. anything less than 3 years. In short-term capital gain tax, tax on funds is calculated as per income tax slab of the individual, i.e. 5%, 20% or 30% on the amount of gain.

For Example, Ravi is a sales manager earning INR11,00,000 per annum and invested amount INR 10,00,000 in debt mutual funds for 2 years. The returns earned on this instrument will fall under short-term capital gains and will be taxed as per the Income Tax bracket of Ravi, that is 20% as per Income Tax Act of 2016-17.

Wits 10% ROI, Ravi earned a return of INR 20,000 on this debt mutual fund, then according to his tax bracket, he will have to pay 20% of INR 20,000 as interest which comes down to INR 4000.

2. Long-term Capital Gain tax:

This is applicable on debt mutual funds held for a period of 36 months or more i.e. anything more than 3 years. In long-term capital gain tax, tax on funds is calculated at the rate of 20% with cost indexation on the amount of gain. Indexation is the adjustment of your purchase price with respect to effect of inflation in an economy and helps you to pay low taxes on your capital gain.

For Example, Ravi invested amount INR 10,00,000 in debt mutual funds for 5 years. Since this fund is held for more than 3 years, the returns earned on this instrument will fall under long-term capital gains with indexation at 20%. Now calculate the Indexed cost.

Indexed cost = (Cost of investment) X (CII for the year of sale/ CII for the year of purchase)

CII stands for Cost Inflation Index where the base year is FY 1981-82. The cost inflation index number is released each year by the central tax authorities. As future CII is not known, so let’s say Ravi investment in FY 2011-12 and sale the debt mutual bond in FY 2016-17.


So now we have,

CII for FY 2011-12- 758

CII for FY 2016-17- 1125

Cost of investment = INR 10,00,000

Indexed Cost = (1125/758) X 10,00,000 = INR 1484169

Hence, Long-term Capital gains

= INR 10 lakhs @ 10% for 5 years – INR 1484169

= INR (15,00,000-1484169)

= INR 15,831 is long term capital gain which will attract tax @20%.

The tax liability with indexation is 20% of INR 15,381 which is roughly equivalent to INR 3166. This indexation helps in lessen the tax burden by taking inflation in account.

Hope you understand all about how taxation works on debt mutual fund.

Happy investing.

Mutual fund investments are subject to market risks. Please read the scheme information and other related documents carefully before investing.
Past performance is not indicative of future returns. Please consider your specific investment requirements, risk tolerance, investment goal, time frame, risk and reward balance and the cost associated with the investment before choosing a fund, or designing a portfolio that suits your needs.