As investors, we often overlook taxes on our investment returns. The reason being, tax rates vary for different asset classes, which can make things complicated. For debt mutual funds, we need to be aware of two types of taxes on investment gains: short-term capital gains tax (STCG) and long-term capital gains tax. In this article, we will focus on STCG for debt mutual funds. But first, let's define what STCG means for debt-oriented mutual funds.
Taking forward the above example, if you invest ₹10 lakh in an equity mutual fund and sell it before one year, you will be charged a 15% short-term capital gains tax, which comes up to ₹1.5 lakh. Additionally, you will also have to pay Securities Transaction Tax (STT), which must be paid by investors when they buy or sell equity funds.
If you invest ₹10 lakh in a debt mutual fund and sell it before three years, you will be charged a 30% short-term capital gains tax, which comes up to ₹3 lakh. It's important to keep in mind the tax implications when making investment decisions, especially for debt-oriented mutual funds.
Effective from April 1, 2023, the Indian government has eliminated the indexation benefit previously available for long-term capital gains on debt mutual funds. This change in taxation will impact investors who hold debt-oriented mutual funds as a long-term investment.
The tax you pay on short-term capital gains from debt mutual funds depends on your income tax rate. This means that your gains get added to your taxable income for the year and taxed accordingly.
The tax rate for short-term capital gains varies depending on your income tax bracket and can be as high as 30%. Even if you're not in the top tax bracket, you'll still have to pay a significant amount of taxes.
To give an example, if you're in the 15% tax bracket and you sold debt fund units before three years, you'll have to pay a 15% short-term capital gains tax on ₹1.3 lakh.
To sum up, it's important for investors to know about taxes on returns, especially for debt mutual funds. If you hold investments for less than 36 months, you'll have to pay short-term capital gain tax (STCG). The amount of tax you'll have to pay depends on your income tax slab rate, which can be as high as 30%. So, before investing in debt-oriented mutual funds, make sure to think about the taxes you'll have to pay and how they'll impact your investment decisions.
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Taxation on funds varies based on the fund type and holding period. The following are the differences in taxation between equity and debt funds:
For equity and debt mutual funds, there's no current way to avoid capital gains tax on your short-term returns. If you make short-term gains from debt funds, you'll pay capital gains tax at the applicable income slab rate.
Debt fund gains sold within three years are taxed at the investor's income tax rate.
Debt fund units sold after 3 years are taxed at a 20% flat rate with additional cess and tax surcharges. Indexation benefits apply.
Short-term capital gains are taxable, but some income levels are exempt from paying taxes on STCGs. These include: