(New) Tax Rules For Debt Mutual Funds In 2025 – What Every Investor Must Know

Understanding the tax on debt mutual fund investments is crucial, especially after the 2023 rule changes. While these funds are preferred by low risk investors for stability, their post tax returns can vary widely. This makes it essential to know how capital gains from debt mutual funds are taxed in 2025 and how it impacts your overall investment returns.

In this blog, we will take a detailed look at the tax on debt mutual funds 2025. 

Understanding Debt Mutual Funds And Their Taxation

A mutual fund scheme is considered a debt mutual fund if it invests more than 65% of its portfolio in debt and debt-related instruments. Debt mutual funds invest in fixed-income securities and carry less risk as compared to equity mutual funds. 

The taxation rules for debt mutual funds are based on holding periods, types of income like capital gains or interest income, and the residency status of the investors. 

Latest Tax Rules For Debt Mutual Funds

Let us understand the latest 2025 debt mutual funds taxation rules in detail:

1. Taxation For Investments Made (BEFORE) April 2023

Tax on Debt mutual fund investments made before 1st April 2023 is as follows¹ - 

1. It will be treated under long-term capital gains (LTCG) if held for longer than 24 months in the case of unlisted schemes and 12 months for listed schemes. (being sold after 23rd July 2024)

2. LTCG on debt mutual funds will be taxed at 12.5% on gains above INR 1,25,000 without indexation benefit. The benefit of indexation has been completely removed.

3. If the debt mutual fund returns are redeemed before 24 months, it will be taxed as short-term capital gains, based on individual tax slab. 

2. Taxation For Investments Made (AFTER) April 2023

The debt fund capital gains tax on investments made after 1st April 2023 will be added to an individual taxable income and taxed at their respective slab rates². 

Irrespective of the holding period, there will be no classification as long-term or short-term capital gains. There will be no debt mutual fund indexation benefit either. 

For example:  Mr A invested INR 20,00,000 in a debt mutual fund on 10th April 2023 and sold the investment for INR 24,00,000 on 30th March 2025, making a profit of INR 4,00,000. Assuming he has no other income, the gains will be taxed on his applicable tax slab. 

Mr. A will be paying a STCG of INR 5,000 according to his applicable slab rate. 

3. Impact Of Budget 2025: Section 87A Rebate and Exemption Limits

Section 87A of the income tax act provides tax rebates to the taxpayers whose annual income is below a certain threshold³. This step is aimed at providing low or no tax burden on low income (below the threshold) earners. 

In Budget 2025, the government raised the income limit for claiming the tax rebate under Section 87A from INR 7,00,000 to INR 12,00,000 under the new tax regime for FY26. The maximum rebate amount has also increased from INR 25,000 to INR 60,000. 

Gains from debt mutual funds purchased after April 2023 are now subject to taxation at slab rates. Investors can incorporate these gains to potentially claim section 87A rebates (debt funds), allowing for tax benefits of up to INR 60,000 for those who qualify.

4. Comparison With Fixed Deposits Taxation

Here is the comparison between fixed deposits and debt mutual funds taxation:

After April 2023, debt mutual funds and fixed deposits have similar taxation. The gains on debt funds and interest income on fixed deposits are taxed at individual income tax slab rates. 

Neither debt mutual funds nor fixed deposits are impacted by holding periods or tenure, and none of them offer indexation benefits. 

Types Of Taxes On Debt Mutual Funds

Here are the different types of debt mutual funds tax charges: 

1. Short-Term Capital Gains (STCG) on Debt Funds

A debt mutual fund investment will be treated under STCG if: 

• Investment is made before 1st April 2023 and held for less than 24 months. 
• Investment is made after 1st April 2023, regardless of the holding period. 

STCG on debt funds will be taxed at the slab rate of the individual.

2. Long-Term Capital Gains (LTCG) and Indexation Changes 

LTCG in debt mutual funds is applicable only if the investment was made before 1st April 2023 under the following conditions - 

• Investment is held longer than 24 months and is being sold after 23rd July 2024. 
• A tax of 12.5% is applicable on gains above INR 1,25,000. 
• No indexation benefit. 

Earlier the gains on debt mutual funds, sold before 23rd July 2024, where investment was made before 1st April 2023, were –

• Taxed at 20% LTCG tax⁴. 
• The indexation benefit was available. 
• The holding period cut-off was 36 months.  
• The exempted gains were INR 1,00,000. 

3. Dividend Taxation on Debt Mutual Funds

The Income Distribution cum Capital Withdrawal or IDCW option in debt mutual funds allows investors to receive periodic payouts from the scheme’s profits (not guaranteed). 

Since April 1, 2020, payouts or dividends from IDCW are added to the investor’s total income and taxed according to their income slab, as the Dividend Distribution Tax (DDT) has been abolished.

A TDS of 10% is deducted if the dividend income is higher than INR 5,000⁵. 

4. Tax Deducted at Source (TDS) For NRIs 

Debt mutual funds tax for NRI or Non-Resident Indians consists of a tax deducted at source: 

• A 20% TDS (or the rate specified under the relevant Double Taxation Avoidance Agreement, whichever is lower) is deductible for NRIs on dividends from debt mutual funds. 
• For redemption on debt mutual funds, a TDS of 30% is levied on capital gains. 

For resident investors, a 10% TDS is deducted on IDCW payouts exceeding INR 5,000 in a financial year, while no TDS applies on capital gains.

Also, no Securities Transaction Tax or STT is levied on debt mutual fund transactions, only on equity-oriented schemes. 

Strategies To Save Tax On Debt Mutual Funds

Let us look at some tax strategies for debt mutual fund investors:

1. Use Growth Option: Instead of availing dividends, you can choose a growth option in debt mutual funds where your dividends are reinvested and allow your investment to compound. 

Otherwise, if you receive dividends each year, you will be liable to pay taxes. 

2. Spread Redemption Across Maturities: If you have invested in debt funds before 1st April 2023, you can spread out the redemptions across financial years to avail the benefit of INR 1,25,000 annual exemption from the long-term capital gains tax. 

3. Utilise 87A Rebate Benefit: In FY26, under section 87A of the IT Act, a tax rebate of INR 60,000 is allowed on incomes up to INR 12 lakhs. This effectively makes income up to INR 12 lakhs tax-free. This includes gains from debt mutual funds. This creates a significant opportunity for middle-income investors to realise capital gains on debt mutual funds tax-free, provided they stay within the threshold.

Conclusion 

The capital gains on debt mutual funds are taxed at the slab rate of the individual if the investment is made on or after 1st April 2023. If the investment is made before that date, a LTCG tax is levied on the gains. The dividends received from debt mutual funds are also taxable at the slab rate of the individual. Investors must properly understand the tax implications of debt mutual funds before investing. 

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FAQs On Debt Mutual Fund Taxation

1. What Is the Tax Rate on Debt Mutual Funds in 2025?

Gains earned on debt mutual funds that are purchased after 1st April 2023 are considered short-term capital gains. These gains are taxable at the tax slab of the investor. Dividends received are also taxable on slab rates. If debt mutual funds are purchased before 1st April 2023, they are treated as long-term capital gains if held for more than 24 months and treated as such. 

2. How Does Indexation Work for Debt Funds Now?

If the debt mutual fund investment is made before 1st April 2023 and redeemed before 23rd July 2024, then LTCG is applicable at 20% (on gains over INR 1,00,000) on holding above 36 months. If the investments are purchased before 1st April 2023 and sold after 23rd July 2024, then they will be taxed according to new LTCG rules at 12.5% (gains above INR 1,25,000) without indexation if held for over 24 months. 

3. Are Debt Mutual Funds Still Tax-Efficient? 

If you are a debt mutual fund investor looking forward to investing in 2025, then all the capital gains will be taxed according to your income tax slab rate. Since, in FY26, incomes up to INR 12,00,000 are tax-free, you can avoid paying taxes if your total income, including gains from debt mutual funds, is below that threshold. 

References

1. The Economic Times, accessed from: https://economictimes.indiatimes.com/industry/services/property-/-cstruction/the-future-of-the-office-from-square-footage-to-experience-per-square-foot-at-millennium-towers-pune/articleshow/121649067.cms 

2. The Economic Times, accessed from:  https://economictimes.indiatimes.com/industry/services/property-/-cstruction/the-future-of-the-office-from-square-footage-to-experience-per-square-foot-at-millennium-towers-pune/articleshow/121649067.cms

3. The Business Today, accessed from: https://www.businesstoday.in/personal-finance/tax/story/as-mf-investor-are-my-gains-excluded-from-the-section-87a-rebate-calculation-under-new-tax-regime-in-fy2025-26-474519-2025-05-02

4. The Business Today, accessed from:  https://www.businesstoday.in/personal-finance/tax/story/budget-2025-ltcg-for-mutual-funds-got-revised-in-budget-2024-how-investors-got-impacted-457885-2024-12-19

5. The Economic Times, accessed from:  https://economictimes.indiatimes.com/wealth/tax/dividend-received-from-shares-and-mf-is-taxable-heres-how-to-reduce-your-tax-outgo-from-dividend-income-in-your-itr/articleshow/111655050.cms

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