Tax on debt funds depends on investment tenure

One of the ways that companies raise funds is through debt funds. They borrow (collect) money from investors (in the form of investments) for a certain term. In return, the company pays investors a fixed interest income for that period. It is a great investment avenue for those who are not willing to take high risks and yet seek capital protection, while earning steady returns. Many investors are drifting to debt funds from Fixed Depositsfor better returns. Let us explore how to calculate gains on sale of debt funds.

Capital gains on debt funds

Debt funds are short-term to medium-term investments. Open-ended schemes allow you to sell and redeem your fund any time you want, while in case of close-ended schemes, you may have to wait till the maturity date. Whether it is for redemption or selling, it is important to be aware of how much gains you will make on the transaction. It varies as per the plan you have opted for – growth or dividend and the underlying securities.

Calculate gains on debt fund sale/redemption

Basically, you can just subtract initial investment from the current sale/redemption value to estimate the capital gains. The income tax act defines how capital gains on sale of debt funds should be calculated. Since debt funds provide a fixed income, regardless of the market movement, it is easier to track the current value of your debt fund unit price and calculate capital gains. However, it also depends on whether you opted for a growth fund or a dividend fund. Please follow the below steps to calculate accurately.

Find out details from debt fund statement

Using your folio number get your your recent account statement and check if your fund is a growth debt fund or dividend one. If you have selected a dividend option while investing, you will receive the dividend (which is the fixed income or interest) regularly as decided. The dividend distribution tax (DDT) is capped at 25%, which is paid by the mutual fund itself. Please note that after disbursing the dividend to investors, the NAV (Net Asset Value) drops, because of this your capital gains may be little to zero. However, capital gain is applicable on the sale of units of a debt fund whether it is dividend or growth

Calculating short-term and long-term capital gains

The tax impact depends on the tenure you have chosen to invest in. So, get the number of days you have invested in – count the number of days from the day of purchase to the day of sale or redemption. If the investment period is less than three years (36 months), the gains during that period become short-term capital gain. If you invest for more than three years, then the profit earned from the debt fund is called long-term capital gain.

Taxation on short-term and long-term capital gains

Take the sale or redemption value you received and deduct it from the initial investment you made. This calculation would work if you are computing the capital gains for debt funds which have been held for short term, that is, for less than 36 months. The tax on such gains would be calculated by applying the individual slab rate on these gains.

In case the units have been held for more than 36 months, then one needs to determine the indexed cost of acquisition of the units of the fund and reduce this from the sale or redemption value. Indexation is nothing but adjustment against inflation. Indexation of cost is done by applying CII (Cost Inflation Index) to the purchase price. Multiply the purchase price by CII of year of sale and divide it by CII of year of purchase. This will give you the value of the long-term capital gains. You can determine your tax liability on such gains by calculating 20% on the long term gains that you have calculated

The writer is founder and CEO, ClearTax