Tax on Debt Funds/ Bonds/ Debentures: Computation with Examples


With Debt Funds, Bonds & Debentures getting popular among the investors, and investors starting to shift from Fixed Deposits to Debt Funds, tax on debt funds/ bonds/ debentures is something that needs to be understood before making investments in a Debt Fund.

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This article mainly deals in computation of tax on Bonds/Debentures/ Debt Mutual Funds. For computation of tax on Equity Oriented Mutual Funds kindly refer our article on Computation of Tax on Shares and Equity Mutual Funds.

Computation of Tax on Debt Funds

Tax on Bonds/Debentures/ Debt funds is computed in a different manner for Short Term and Long Term Investments. The Investment in Debt Fund is classified as Short Term/ Long Term on the following basis:-

Debt Fund held for more than 3 years : Short Term Investment

Debt Fund is held for more than 3 year : Long Term Investment

In case of Short Term Investments, tax on debt funds would be levied at the time of sale as per the income tax slab rates in force.

In case of Long Term Investments as per Section 112, the tax would be levied @ 20% of profit earned at the time of sale.

The duration for which these Funds were required to be held to be classified as Long Term was earlier 1 year but this has been increased to 3 years in Budget 2014. Earlier the rate of Tax on Long Term Gains was also 10% which has now been increased to 20%. These changes are applicable from Financial Year 2014-15.

It is important to note here that no STT is paid on the sale of Debt Funds/ Bonds/ Debentures whereas STT is paid on the sale of Mutual Funds. And therefore, no tax is levied on the sale of mutual funds in case the period of holding is long term whereas tax on sale of Debt Funds is liable to be paid.

Tax on Interest on Debt Funds: Interest received on Debt Funds is tax free in the hands of the Investor.


Example showing computation of Tax on Debt Funds/ Bonds/ Debentures

1000 units purchased @ Rs. 12= Rs. 12000

1000 units sold @ Rs. 18 = Rs. 18000

Profit on sale 18000-12000 = 6000

Now if this investment was short term, tax would be levied as per the existing Income Tax Slab Rates.

However, if this income was long term, tax would be levied either at flat 20% which would be 20% of 6000 = Rs. 1200.

Or in case the investor wants to make use of the cost inflation index, he shall use the following formula for computation of profit:-

Profit = Sale price – Indexed Cost of Acquisition

Indexed Cost of Acquisition = Purchase Price *Cost Inflation Index of the year of Sale
Cost Inflation Index of the year of Purchase

Tax on Debt Fund/Bond/Debenture in this case would be 20% of the profit amount as computed using the above formula.

Karan is CA by Qualification with the rare distinction of being awarded All India Rank 22. He is also the founder of this website and loves to help people with their Tax Queries.