How Indexation Works In MFs

The Finance Act, 2023 has taken away the indexation benefit from debt mutual funds but those having 35-65 per cent exposure to equity are still eligible for it

- JOYDEEP SEN

The Finance Act, 2023, has taken away the indexation benefit from debt mutual funds. It states that the gains from the growth option of funds with equity allocation of less than 35 per cent will be taxed as short-term capital gains (STCG), irrespective of the holding period.

STCG from non-equity funds are taxable at the marginal slab rate. At the highest tax bracket, it is 30 per cent plus surcharge and cess. It effectively means that the indexation benefit, which was there for a holding period of three years, is not available anymore.

The taxation of equity funds remains the same as before. Gains from equity funds held for more than a year in the growth option will be taken as long-term capital gain (LTCG), and will be taxed at 10 per cent plus surcharge and cess. On a holding period of less than one year, equity funds are taxable at 15 per cent plus surcharge and cess.

The changes in mutual fund taxation through the Finance Act 2023, has opened up a third category of funds for taxation purpose. At present, the two existing categories for taxation are equity and debt. Now, we have to distinguish between what we understand as debt funds and what has been stated in the Finance Act, 2023. The Act talks about funds with less than 35 per cent allocation to domestic equity. Hence, it includes debt funds, gold funds, international equity, or, for that matter, any fund with equity allocation less than 35 per cent.

Another aspect to note is that it is not mentioned anywhere that indexation benefit has been removed. It states that gains from funds with equity allocation less than 35 per cent will be taxed as STCG, irrespective of the holding period.

New Taxation Category