In the July 2024 budget, the government rationalised the capital gains taxation regime for all assets. From July 23, 2024, LTCG from selling an asset (listed or unlisted securities) are taxable at 12.5% without indexation benefit. However, capital gains on debt mutual funds will continue to be taxed at the income tax slab rate applicable to the recipient’s income instead of the new LTCG tax rate of 12.5%. The question arises as to how capital gains on debt mutual funds will be taxed where investments were made on or before March 31, 2023, and are sold on or after July 23, 2024.
Neeraj Agarwala, Partner, Nangia & Co LLP – a tax consulting firm, says, “Capital gains from the debt mutual fund bought on or before March 31, 2023, which were previously taxed as long-term capital gains at 20% with indexation, will now be taxed at 12.5% without indexation. However, the new LTCG tax rate will be effective for debt mutual funds’ transfer or maturity or redemption done on or after July 23, 2024. Remember, there is no change in capital gain tax rules for debt mutual fund investments made on or after April 1, 2023. All capital gains on these will be classified as short-term and taxed at applicable income tax slab rates, irrespective of the holding period.”
Punit Shah, Partner, Dhruva Advisors – a tax consulting firm concurs: “Long-term capital gains from debt mutual funds’ investments (listed or unlisted) made before April 1, 2023, will now be taxed at 12.5% without indexation. The same will qualify as a long-term capital asset where the holding period is more than 12 months (listed)/ 24 months (unlisted). The change in LTCG tax rules for these debt mutual funds will retrospectively impact investors who invested to avail of the indexation benefit. Hence, taxpayers should check the type of debt mutual fund (listed or unlisted) before redeeming existing debt mutual fund investments. Further, the holding period to categorise the capital gains as long-term has been reduced to 12/24 months from 36 months.”
How does it impact debt mutual fund investments made before April 1, 2023?
The LTCG tax rate for these mutual funds has been reduced from 20% to 12.5%. However, the indexation benefit has been removed. Shah says, “The change from 20% (with indexation) to 12.5% (without indexation) may increase tax liability, as earlier, investors were able to have an increased cost base on account of indexation (which is now done away with). However, it may depend on the facts of each case.”
Agarwala says, “The tax impact due to the withdrawal of indexation will largely depend on the annualised rate of return expected from the debt fund. Generally speaking, if the annualised rate of return is closer to the average increase in the Cost Inflation Index (CII), say between 7% and 9%, the old provision of 20% tax with indexation would be more advantageous for the investor. However, if the annualized rate of return is significantly higher, around 12%, then, as per our estimates, the new provision of 12.5% tax without indexation will likely be more beneficial for the investor.”
There are various types of debt mutual funds. The returns from these investments depend on the securities in which these funds are investing. For instance, overnight funds invest in bonds with one-day maturity, medium-duration funds invest in bonds with a maturity of 3-4 years, and Long-duration funds invest in bonds having a maturity period of more than 7 years.
The returns from these debt funds will vary due to the nature of the investment. Long-duration mutual funds are riskier than short-duration funds due to various risk factors such as interest rate risk and credit risk. Therefore, long-duration mutual funds are likely to give higher returns than short-duration and overnight funds.
Is there any change in the carry-forward and set-off rules for loss?
The government has revised LTCG tax rules for debt mutual funds’ investments that were made on or before March 31, 2023. The returns from debt mutual funds are subject to market risks. Hence, there can be instances where loss is incurred on redemption of such debt mutual fund units. What will be the carry-forward and set-off rules for the loss in that case?
Shah says, “Loss on sale of debt mutual funds which were bought before April 1, 2023, can be set off against capital gains from other assets as per known rules. This would mean that loss from such debt mutual funds can be set off against the capital gains from other assets depending on the nature of the capital loss/gains. Long-term capital loss can be set off against long-term capital gains, and short-term capital losses can be set off against short-term capital gains and long-term capital gains. The losses (short or long) can be carried forward for 8 financial years. Loss on debt mutual fund investments made on or after April 1, 2023, will qualify as short term capital loss and can be set-off against long-term capital gains or short term capital gains arising from any other asset. If there are losses from the sale of debt mutual funds, then they will be calculated without indexation benefit – both long term and short term.”
