A debt mutual fund invests primarily in debt instruments, that is government securities, bonds and money market instruments.
A debt mutual fund is defined as one which invests less than 65% of its assets into equities. Let us check on what taxation of debt mutual funds means to the retail investor.
The scope of the below discussion is individuals and HUF only and for Assessment Year 2010-2011 or Financial Year 2009-2010.
Taxation of dividends of debt mutual funds
All dividends received from debt mutual funds are tax free in the hands of the investor(Individual/HUF). One does not gave to pay any tax on it. Good going ?
For debt mutual funds, there is no tax on dividends you receive from it.
But then there is an evil called DDT !
Though the dividend from debt mutual funds is tax free in the hands of the investor, the mutual fund house has to pay something called the Dividend Distribution Tax (DDT). The DDT that is paid is in no way connected to the investor in any way, all debt mutual funds will have to pay this. In a sense, one could say that this is indirectly borne by the investor himself.
DDT ranges between 14% – 28%.
For debt schemes, the exact DDT is 14.163% and for money market and liquid schemes it is 28.325%.
Capital Gain Taxation
If a mutual fund is held for less than one year, it classifies as a short-term capital asset and if it is held for more than one year, it becomes a long-term capital asset. The gains arising from the sale of a short-term capital asset are called short-term capital gains and the gains arising from the sale of a long-term capital asset are called long-term capital gains.
For debt mutual funds
- The long term gain is taxed at 10% without indexation and 20% with indexation.
- The short term capital gain is added to the taxable income of the individual and taxed according to applicable tax slab.
As you can see, the short term capital gain can really hurt a lot as a majority of the gains is shaved off as tax that one needs to pay up to the government depending on which tax bracket one falls in.
The snapshot below summarizes the various tax aspects of Debt Mutual Funds for an individual which we have discussed above.
Hope this helps readers to clear out some cobwebs.