A brief tax guide to debt mutual funds

Investing in debt mutual funds equates to varying risk levels, depending on the type of fund chosen and maturity among other aspects. Debt funds naturally have risks related to interest rates and credit risks, making them slightly riskier in comparison to bank fixed deposits and the like. Liquid funds are often chosen by people with investment horizons ranging between 3-4 months to a year or so while 2-3 years is usually chosen for short-term bond funds. Dynamic bond funds may be suitable for investment periods of 3-5 years.

Debt mutual funds can be smartly used to enhance your income and supplement what you earn from your salary/business. You may also invest a portion in debt funds for liquidity purposes. They may also be good avenues for those investing for retirement. Debt mutual funds are usually considered safer bets in comparison to equity investment funds.

Some key aspects worth remembering

You can expect comparatively lower returns from debt mutual funds in comparison to the riskier equity fund investments. Here are the returns that you will be getting:

• Income that you get in the form of interest.
• Appreciation of capital on the basis of market changes.

Debt funds usually have various types which are sub-divided on the basis of the instrument in which the investment is made. Some of the commonly preferred types include liquid, floating rate, ultra short term and corporate bond funds among others.

Taxation in case of debt mutual funds

Taxation upon debt mutual funds depends on several factors including the various types of funds in the market. There are two kinds of taxes imposed on these funds, namely Long-Term and Short-Term Capital Gains tax.

• Short-term- The debt fund that you hold for a period which is lower than 3 years will be classified as a short-term investment. This will be worked out on the basis of your specific income tax slab. Suppose someone earns approximately Rs. 12 lakh annually and based on the prevailing tax slab, the rate of taxation will be 30%. Now, consider that Rs. 1 lakh was invested by this person in debt funds for a tenor of 2 years. Since the period is lower than 3 years, the returns (interest) earned from this particular investment will be treated as short term capital gains. They will be taxed as per the person’s income tax slab, i.e. 30%.
• Long-Term- If you hold a debt fund for a period exceeding 3 years, it will be worked out as a long term investment. The taxation will be under long term capital gains and the rate will be 20% with indexation. There will be an additional 3% cess levied, taking the overall rate to 20.90%.

As can be seen, taxation varies from one person to another, depending on the type of debt fund invested in and other factors. Make sure that you read up on taxes, associated costs and other vital aspects of debt mutual funds before investing.