How do debt mutual funds qualify for indexation benefits?

Debt mutual funds qualify for indexation benefits if they are held for more than 3 years. This means investors can adjust the purchase price using the cost inflation index (CII), which reduces taxable capital gains and overall tax liability. Indexation is a key tax-saving feature that makes long-term debt fund investments attractive.

What Is Indexation in Mutual Funds?

Indexation is a method used to adjust the purchase price of an investment based on inflation. It uses the Cost Inflation Index (CII) published by the Income Tax Department. The adjusted cost helps lower the taxable capital gain, thereby reducing your tax liability.

Debt mutual funds held for more than three years were earlier eligible for long-term capital gains (LTCG) tax with indexation, making them highly tax-efficient compared to traditional fixed income options.

How Debt Funds Qualified Earlier

Before April 1, 2023, debt mutual funds that invested less than 35% in equity were eligible for LTCG tax after 3 years, and investors could apply indexation to calculate capital gains. This helped reduce taxes significantly, especially during high inflation years.

The indexation formula used was:

Indexed Cost = Purchase Price × (CII of Sale Year / CII of Purchase Year)

Recent Changes in Taxation of Debt Funds

As per the Finance Bill 2023, indexation benefits have been removed for debt mutual funds purchased on or after April 1, 2023, that have less than 35% equity exposure. These funds are now taxed as per the investor’s income tax slab, even if held for more than 3 years.

However, investments made before this date still qualify for indexation benefits if held for the required period. So, historical investments remain tax-efficient if held long term.

Why Indexation Still Matters

If you invested in debt mutual funds before April 2023, indexation can still be used to reduce your taxes. It makes sense to hold those investments for more than three years to fully utilize the benefit.

For new investors, although indexation is no longer available, debt funds still offer advantages like liquidity, diversification, and potential for higher returns compared to fixed deposits.

Debt mutual funds offered a smart way to earn better post-tax returns with indexation benefits before the 2023 rule change. If you had invested before that date, make sure to hold them long enough to benefit from indexation. Even now, debt funds remain a flexible and valuable option for conservative investors looking for stable growth.