Be more tax-efficient with debt mutual funds

Apart from adding diversity to your portfolio, other than equity-oriented mutual funds also help you in saving tax on the capital gains that you earn from investment. More often than not, investors tend to look at their capital gains as a simple profit/loss account, which may not be the ideal way. For example, if you invested Rs 10,000 five years back in a Mutual Fund and the value of your investment today is Rs 15,000, you may say that your capital gain is Rs 5000. However, there will be a capital gains tax levied on Rs 5000, and the resulting amount will be your tax-adjusted capital gain. Whenever you are looking at your returns, it is better to look at the picture in totality and consider the post-tax returns. Other than equity-oriented fund taxation might help you in minimising the tax that you pay on your capital gains; let us see how.

When you invest in any other than equity-oriented mutual fund, there are two ways in which the value of your investment grows-

• 1. The interest declared on the Other than equity-oriented securities/bonds that the fund invests in.

• 2. The change in bond prices due to interest rate fluctuations.

You can read more about how other than equity-oriented funds work, here. Now, these gains eventually reflect as a change in the Net Asset Value (NAV) of the other than equity-oriented fund you are holding. NAV is the per-unit cost of the Mutual Fund scheme. Taking the above example forward, when you invested Rs 10,000 five years ago, let us say you bought 100 units of the mutual fund scheme at a NAV of Rs 100 each. Now, after five years, the NAV has increased from Rs 100 to Rs 150, and hence the value of your 100 units becomes Rs 15,000. The Rs 5000 that you earned in the process is your capital gain.

No, they are not. But the tax on other than equity-oriented funds is curated in such a way that it reduces the tax burden. Let us see how.

For the purpose of calculation of capital gains tax, the period for which you are invested in other than equity-oriented mutual fund (also known as your holding period), is categorised as below-

Hence, if you redeem your investment within 36 months from the date of investment, Short-Term Capital Gain Tax (STCG Tax) will be applicable on your gain, else, Long-Term Capital Gain Tax (LTCG Tax) will applicable. Taxability of capital gain from other than equity-oriented funds is different for different holding periods, i.e. the tax on short term capital gain will vary from the tax on long term capital gain.

As seen above, if your holding period is less than, or equal to 36 months, then STCG tax will be applicable on your capital gain. In this case, the capital gain is taxable as per the tax slab rates applicable to the investor (For resident Investors). Again, using the same example as above and assuming that you fall into the 30% income tax slab, let us say that the value of your Rs 10,000 investment at the end of 2 years was Rs 12,000. In this case, your capital gain is Rs 2000, which will be taxed at 30%, resulting in an STCG Tax of Rs 600. Hence, your tax-adjusted returns become Rs 1400 (Rs 2000-Rs 600).

Here is where the other than equity-oriented funds helps to minimise tax. You saw how at the end of five years; we have assumed the value of your investment to be Rs 15,000. So, the capital gain here should be Rs 5000, right? Wrong. In this case, the capital gain is taxable at 20% after indexation (For resident Investors). Via indexation, you calculate the new value of your investment, considering inflation, and hence, the capital gains become lesser. The cost of inflation index (CII) is the factor used to determine this value which is declared for every financial year.

Let us see how-

Indexed value= (CII of the sale year/CII of the purchase year) * original investment value

Your indexed value will be (301/254) *10,000= Rs 11,850.39
Now, your capital gain = Rs 15,000- Rs 11,850.39= Rs 3149.6
And the LTCG Tax @20% = Rs 629.92

Without the indexation benefit and at the same tax rate of 20% LTCG, you’d have paid a tax of Rs 1000 (20% of Rs 5000). It is a small difference here in the above mentioned example, but when your investment and redemption run in lakhs, the tax amount can be huge.

Thus, the other than equity-oriented mutual fund returns over long-term are made both, tax-efficient and inflation-sensitive by introducing indexation benefit.

Please note that the above calculations are done exclusive of the cess chargeable in addition to the capital gains tax.