Tax on Debt Mutual Funds: How Are They Taxed in 2025-26?

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Debt mutual funds are investment options that pool money into fixed-income securities such as government bonds, corporate debt, and treasury bills. If you're wondering What are debt funds, they are designed to offer stable returns with relatively lower risk compared to equity investments. In the financial year 2025–26, tax on debt mutual funds depends on when they were purchased and the prevailing tax laws. This article outlines the tax rate on debt mutual funds, recent budget updates, and factors that influence tax liability for investors.

These rules affect how much tax investors will have to pay when they sell their funds. The information is based on laws. Understanding this helps individuals make better financial choices in the current fiscal year.

Debt Mutual Fund Taxation Rules for FY 2025-26

The rules around tax on debt mutual funds have evolved significantly following the Finance Act 2023 and updates in Budget 2025. For individuals engaged in strategic Wealth Management, knowing the tax implications of both pre- and post-2023 debt fund investments is crucial to optimizing after-tax returns.

1. Post-April 1, 2023, Investments

For debt mutual funds purchased on or after April 1, 2023, taxation is straightforward but potentially more expensive:

• All gains, regardless of how long the fund is held, are taxed as short-term capital gains
• These are taxed at the investor’s income tax slab rate
• There's no indexation benefit and no separate long-term capital gains treatment

This shift in debt funds taxation removes the earlier advantage of lower long-term rates and makes post-2023 investments subject to regular income tax. It affects most investors seeking stable returns through fixed-income instruments.

2. Pre-April 1, 2023 Investments

Older investments in debt funds still benefit from the earlier, more favourable tax rules:

• Short-Term Capital Gains (STCG)
• For holdings of 36 months or less
• Taxed at the investor’s applicable slab rate

• Long-Term Capital Gains (LTCG)
• For holdings over 36 months
• Taxed at 20% with indexation, which adjusts cost for inflation

This structure continues to apply for legacy investments and is a key consideration when redeeming units. It allows for a reduced long term capital gain tax on debt mutual funds by factoring in inflation.

3. Budget 2025 Highlights for Debt Mutual Funds

Budget 2025 introduced a broader tax relief for individuals under the new tax regime:

• The Section 87A rebate, introduced in Budget 2025, adds a layer of relief for those holding post-2023 debt mutual fund units. When comparing fixed income options, Debt Funds vs Fixed Deposits becomes a common debate due to differing risk profiles and tax efficiency.
• Full tax exemption for individuals with income up to ₹12 lakh

This update indirectly benefits those earning interest or gains from post-2023 debt fund investments, as the gains—taxed at slab rates—can be offset more effectively within this higher rebate limit.

Note: The rebate does not apply to LTCG taxed at the flat 20% with indexation, relevant only for pre-2023 investments.

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Summary Table: Capital Gains Tax on Debt Mutual Funds (FY 2025-26)

This table provides a gist of how debt MF taxation applies in the current financial year and can help investors make informed redemption and reallocation decisions.

Factors Affecting Taxation in 2025-26

Several factors determine tax liability for debt mutual funds in 2025-26:

• Purchase Date:
• Pre-2023: Eligible for 12.5% LTCG if held over 24 months.
• Post-2023: All gains taxed at slab rates.

• Income Slab: Higher slabs (e.g., 30%) increase tax on post-2023 gains and pre-2023 STCG.
• Holding Period: For pre-2023 funds, over 24 months qualifies for 12.5%; shorter periods use slab rates.

Other considerations include total income, which impacts slab rate applicability, and the new regime choice, which enables the Rs. 60,000 rebate. Investors must evaluate these elements carefully.

High Net-Worth Individuals (HNIs):

The Finance Act 2023 introduced Section 50AA, stipulating that gains from specified mutual funds (where not more than 35% of total proceeds are invested in equity shares of domestic companies) are deemed short-term capital gains, irrespective of the holding period, and taxed at the investor's applicable income tax slab rate.

Non-Resident Indians (NRIs):

NRIs investing in debt mutual funds in India are subject to Tax Deducted at Source (TDS) at 20% or at the rate specified under the relevant Double Taxation Avoidance Agreement (DTAA), whichever is lower. To mitigate tax liabilities, NRIs can utilize DTAAs by submitting relevant tax residency certificates and forms, allowing them to claim credit for taxes paid in India against their tax obligations in their country of residence.

Conclusion

Debt mutual fund taxation in FY 2025–26 depends primarily on when the investment was made. Gains from pre-April 2023 funds held over 36 months are taxed at 20% with indexation, while all gains from post-April 2023 investments are taxed at slab rates without indexation.

The enhanced rebate under Budget 2025 offers relief under the new regime, especially for moderate-income investors. Understanding how debt funds work along with the latest tax norms empowers investors to align their portfolio with both income level and holding strategy, ensuring smarter financial decisions in FY 2025–26.

Disclaimer: This blog is for informational purposes only and does not constitute tax or investment advice; please consult a financial advisor for personalized guidance.

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