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Tax treatment of your debt fund capital gains

Earnings from debt funds can come either in the form of dividends or capital gains or even both. While dividends are tax free after you have received them, capital gains are taxed post being realised. Here is how you add the capital gains to your tax return filing.

One has to admit that investing in debt funds is not as intuitive as buying a bank fixed deposit. However, given the flexibility, performance history and taxation they present a more efficient way to build your fixed income allocation. What you do need to know are the differences in reporting your gains from debt funds while filing your tax return.

Earnings from debt funds can come either in the form of dividends or capital gains or even both. While dividends are tax free after you have received them, capital gains are taxed post being realised. 

Here is how you add the capital gains to your tax return filing. 

What are capital gains?

Capital gains arise when you redeem your fund at a higher price than what you invested at. The difference in the buy and sell price is your capital gain. Typically, capital gains arise if you invest in the growth option of your debt mutual fund, however, even with the dividend option, at the time of redemption you may have some capital gain. 

Any capital gain which is realised or booked at the time of redemption is liable to be taxed along with the rest of your income for a given financial year. For debt mutual funds, capital gains are classified as short term if you sell or redeem your fund before 36 months of holding. Selling after 36 months will result in long term capital gains. This is relevant as the rate of tax applicable for both is different. Long term capital gains have the benefit of indexation on the cost of purchase, which lowers the gains reported for taxation. 

Short term capital gains are taxed at your income tax rate. To show the gains in your return filing you will still have to include a separate heading of capital gains and include the short term and long-term gains separately. Long term and short-term capital gains need to be shown separately too.

Short term capital gains are taxed at the rate applicable for your income tax and long-term capital gains (post indexation) are taxed at 20%. 

Where does this fit in the tax return?

Short term capital gains are taxed at your income tax rate. To show the gains in your return filing you will still have to include a separate heading of capital gains and include the short term and long-term gains separately. Long term and short-term capital gains need to be shown separately too.

Income tax act allows you to adjust short capital gains against any other short- or long-term capital loss you may have incurred. Similarly, you can adjust any long-term capital gains from your debt funds against long term capital loss. For example, if you have a Rs 100 long term gain from your debt mutual fund and a Rs 100 long term capital loss from your equity fund, then your net long term capital gains for tax purpose is Rs 0. This is how set off of capital gains and losses from your debt funds (or any other capital asset) can happen for your tax filing. 

Knowing about the relevant taxation will help you make a more informed choice when it comes to investing and when it comes to redeeming your debt funds. It is important to know the impact of taxation on your overall return and income, however, don’t let tax become your only guide to making an investment choice.

 

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