Tax Planning • FY 2024-25
Debt Funds (Post‑2023): What Changed and How to Invest
The indexation era for new debt‑fund units is over. That doesn't kill debt MFs—it just changes why you hold them. The pros re‑underwrite: liquidity, risk budget, and goal‑matched ladders over tax magic.
What Exactly Changed (Finance Act 2023)
- Specified Mutual Funds (SMF): New rule treats funds with ≤35% domestic equity exposure as SMF. For units acquired on/after 1 Apr 2023, gains are taxed at slab rates irrespective of holding period (no LTCG rate, no indexation).
- Legacy remains: Units acquired before 1 Apr 2023 retain old treatment: >36 months = LTCG with indexation; ≤36 months = STCG at slab. Track lots carefully.
- Who's impacted: Most debt categories (liquid, money market, ultra‑short, short‑term, corporate bond, gilt/constant maturity), gold ETFs, many international funds and FoFs, and asset‑allocation funds with <35% Indian equity.
Which Categories Are Affected?
- All debt mutual funds (across duration buckets).
- Gold ETFs and most international funds.
- FoFs (especially international FoFs) unless they maintain >35% domestic equity.
- Target Maturity Funds (TMFs): new units taxed at slab; legacy lots may have indexation.
- Multi‑asset/asset‑allocation funds with <35% domestic equity exposure.
Equity‑oriented funds (typically >35% domestic equity with STT paid) continue with equity taxation: STCG 15% (≤12 months), LTCG 10% above ₹1L (>12 months).
So… Are Debt Funds Dead? Not Really.
Debt MFs still solve problems FDs don't: portfolio segregation, mark‑to‑market transparency, easy rebalancing, and access to gilt/corporate curves. The difference is you now buy them for liquidity and laddering, not indexation.
- Target Maturity Funds: Date‑locked portfolios that can match goals (e.g., 2028/2030 ladders). You trade indexation for simplicity; evaluate YTM‑minus‑expense against your slab.
- Liquidity buckets: Liquid/ultra‑short for emergency and near‑term cash with T+1/T+0 access and low credit risk.
- Credit discipline: Use corporate bond/gilt funds for policy‑rate cycles and duration calls—but size risk prudently.
Pro move
In the 30% slab, push the long‑term fixed‑income sleeve to EEE wrappers (PPF/EPF) first. Use debt MFs for liquidity ladders and tactical duration, not tax.
Rules of Thumb (Allocation Decisions)
- Goal ≤ 6 months: bank sweep/liquid fund; tax is secondary to access.
- 6–24 months: ultra‑short/low duration vs short FDs; compare post‑tax + exit load.
- 3–7 years with date certainty: build a TMF ladder; compare YTM minus expense vs your slab and alternative FDs/SSCs.
- Gold exposure: consider SGBs for tax‑free maturity instead of gold ETFs (if lock‑in is acceptable).
- Top slab: prioritise PPF/EPF; debt MF for liquidity/rebalancing only.
Worked Comparison (Directionally)
3‑year horizon, pre‑tax return assumption 7.5% p.a.
- Debt MF (new units): Gains taxed at slab on redemption. In 30% slab, post‑tax return roughly 7.5% × (1 − 0.30) before expenses.
- Legacy debt MF (pre‑Apr 2023 units held >36m): LTCG with indexation; effective tax often materially lower than slab.
- 5‑yr tax‑saver FD: Interest taxed annually at slab; compare bank rate vs fund YTM after expense and loads.
These are directional; compare actual YTMs, expense ratios, exit loads, and your slab.
Compliance, TDS, and Process
- Dividends (IDCW): Taxed at slab; 10% TDS u/s 194K if total payouts >₹5,000/year.
- Capital gains: For residents, AMCs generally do not deduct TDS on redemption gains; compute and pay with returns/advance tax as applicable.
- Switch/STP: Treated as sale; triggers tax; resets holding period.
- Exit loads & cut‑offs: Check scheme load periods and NAV cut‑off times when building ladders.
Common Mistakes We See
- Assuming indexation on new debt units—post‑Apr 1, 2023 many no longer qualify.
- Switching within the same AMC assuming "no tax"—a switch is a redemption for tax purposes.
- Ignoring exit loads when doing STP or ladder roll‑downs.
- Holding gold only via ETFs when SGBs suit the horizon and offer tax‑free maturity.
- Chasing yield without sizing credit/duration risk relative to goals.
Quick Checklist
- Identify whether your units are legacy (pre‑Apr 2023) or new—track lots separately.
- Match duration to goal date; use TMFs for ladders, liquid for access.
- Compare YTM minus expense to slab‑adjusted alternatives (FD/SSCs/PPF).
- Prefer EEE wrappers (PPF/EPF) for long‑term fixed‑income in top slabs.
- Mind exit loads, IDCW TDS, and switch/STP tax events.