How do debt mutual funds handle indexation benefits in taxation?

Debt mutual funds used to offer indexation benefits if held for more than three years, making them tax-efficient compared to fixed deposits. However, from April 1, 2023, indexation benefits are no longer applicable for debt funds that invest less than 35% in equity. Now, all capital gains from such funds are taxed as per your income tax slab, regardless of the holding period.

What Was Indexation in Debt Mutual Funds?

Indexation adjusts the purchase price of your debt fund units using the Cost Inflation Index (CII) to reflect inflation. This helped reduce your taxable capital gains when you redeemed your investment after 3 years, thereby lowering your tax liability. The effective tax could go as low as 5-8% in some cases due to indexation.

What Has Changed After April 1, 2023?

The Finance Act, 2023 removed the indexation benefit for debt mutual funds that invest less than 35% in equities. These funds will now be taxed as per your income tax slab, even if you hold them for more than 3 years.

This change applies to all investments made in debt funds from April 1, 2023 onwards. Past investments (before this date) continue to enjoy indexation if held for 3 years or more.

Taxation of Debt Mutual Funds (Post-April 2023)

• Short-Term or Long-Term: No distinction now — all gains are taxed as per your slab rate.
• Indexation: Not available for investments made on or after April 1, 2023.
• Applicability: Applies to debt mutual funds with less than 35% equity exposure.

Are There Any Alternatives for Tax-Efficient Investing?

If you are looking for tax efficiency, consider:

• Equity mutual funds (taxed at 10% after 1 year on gains above ₹1 lakh)
• Hybrid funds with more than 35% in equity (some still enjoy equity taxation)
• ELSS funds for tax-saving under Section 80C (with 3-year lock-in)

Debt mutual funds still offer better liquidity, diversification, and returns than traditional FDs. However, the taxation has become less favorable for new investments post-April 2023.

Debt mutual funds used to be a go-to option for smart tax planning using indexation. However, with new tax rules, investors now need to reassess their debt fund investments. Always check the equity exposure in the fund and consult with a financial advisor to choose the right product based on your tax slab and investment goals.