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Short-term capital gains (STCG) tax on debt funds is a tax that is levied on STCG earned by an investor on such funds. Such gains are taxed based on the tax rate applicable to the income-tax slab of an individual.
Investments in debt funds can help an investor earn capital gains. These gains are the difference between the amount invested in a debt fund and the amount earned by selling those investments.
Let us say that an investor invested Rs. 1 lakh in a debt scheme a few years ago. However, today, the value of that investment is Rs. 1.1 lakhs. In this case, he has earned Rs. 10,000 capital gains on this investment, which is the difference between Rs. 1.1 lakhs and Rs. 1 lakh.
If an investor holds an investment in a debt fund for a short term, then it attracts short-term capital gains (STCG) tax. On the other hand, if an investor holds his investment in a debt fund for a long term, then it comes under the purview of a long-term capital gains (LTCG) tax.
Short-term capital gains tax is levied on capital gains arising from an asset, which is held by an investor for a short term. But, what exactly is short-term? For this, you need to read the Income Tax Act because what is short-term for one asset may not be short-term for another asset.
As per tax rules in India, if an investor holds investments in a debt fund for 36 months or less, then he has to pay a short-term capital gains tax on the gains arising from such an investment. An investor has to pay STCG based on his slab rate.
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Debt funds are a kind of mutual funds that predominantly invest in fixed-rate instruments, such as government bonds, corporate bonds, and treasury bills. Compared to equities, debt instruments are considered to be less risky because they provide fixed-interest income.
That said, the price of debt securities increases when interest rates decline, and when interest rates increase, the price of debt securities decreases. Therefore, the value of investments in a debt fund varies based on changes in the level of interest rates. But still, investments in debt funds are less risky than those in equity funds on average.
For a mutual fund to be classified as a debt fund, it should invest less than 65% of its portfolio in Indian equity stocks and related instruments.
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If an investor holds an investment in a debt fund for 36 months or less, then he has to pay an STCG tax on capital gains arising from selling it. However, if an investor holds such an investment for more than 36 months, then he has to pay a LTCG tax on capital gains from this investment.
Both LTCG and STCG are taxed at the slab rate of an investor. So, he has to pay long-term capital gains tax or short-term capital gains tax based on the tax rate applicable to his annual income.
Over and above this, investments in debt funds also attract a dividend distribution tax (DDT). If a debt scheme distributes dividends, then the investors have to pay a DDT of 25%, which increases to 29.12% after including cess and surcharges.
If an investor stays invested in a debt fund for 3 years (36 months) or less, then he has to pay an STCG tax on the capital gains he makes by selling such an investment. Such gains are calculated by deducting the cost of acquiring units in a mutual fund from the sale proceeds of selling the same units.
If the holding period of an investment in a debt mutual fund is more than 3 years (36 months), then you have to pay a LTCG tax on long-term capital gains arising from it. Therefore, it is the holding period that decides whether a sale of a debt fund falls under the purview of STCG tax or LTCG tax.
When it comes to calculating STCG from debt funds, the first thing you need to check is whether it is a debt fund as per the tax rules in India. According to these rules, if a mutual fund invests less than 65% of its corpus in Indian equity stocks and instruments related to that, then it is a debt fund.
The second thing you need to check is whether the investment holding period is 36 months or less. If this is indeed the case, the capital gains on such a debt fund fall under the purview of STCG tax as per rules in the country.
Lastly, you have to pay short-term capital gains tax based on the rate of the income tax slab of your annual income.
Two factors affect the calculation of STCG tax. First, the amount of STCG. The higher the amount of STCG, the higher the tax payable on that. Suppose an investor earned only Rs. 100 as STCG, then tax will be applicable on Rs. 100. However, if he earned Rs. 10,000 as STCG, then he will have to pay tax on Rs. 10,000, which will be much higher than the tax he paid on Rs. 100.
The second factor is an investor’s slab rate. If an investor is falling under a 20% income tax slab, then he will have to pay a 20% tax on STCG. However, if he is falling under a 30% slab, he will be paying a 30% tax on his STCG. At the same time, if an investor’s income is so low that he does not have to pay any income tax, then he will not be paying income tax on his STCG, either.
As already mentioned, an investor has to pay STCG tax based on the income-tax bracket he is falling into. As per the latest tax rules, if an individual’s annual income is up to Rs. 3 lakhs, he does not have to pay any income tax. So, if you are falling under this slab, you do not have to pay any STCG tax.
If an individual’s annual income is between Rs. 3,00,001 and Rs.6,00,000, he has to pay a 5% income tax. If you are in this bracket, you have to pay a 5% STCG tax.
If an individual’s annual income is between Rs. 6,00,001 and Rs.9,00,000, he has to pay a 10% income tax. If you are in this bracket, you have to pay a 10% STCG tax.
If an individual’s annual income is between Rs. 9,00,001 and Rs.12,00,000, he has to pay 15% income tax. If you are in this bracket, you have to pay 15% STCG tax.
If an individual’s annual income is between Rs. 12,00,001 and Rs.15,00,000, he has to pay 20% income tax. If you are in this bracket, you have to pay 20% STCG tax.
If an individual’s annual income is more than Rs.15 lakhs, he has to pay 30% income tax. If you are in this bracket, you have to pay 30% STCG tax.
-To reduce the tax liability in such a case, an investor can invest in hybrid funds. Hybrid funds are mutual funds with investments in debt and equity instruments higher than 35% but less than 65% of their portfolio.
-For example, a fund may invest in such instruments that are going to give a low rate of return. Even if he has to pay a low tax on such a return, his post-tax returns may be quite low. Therefore, before deciding which fund to invest in, an investor should assess their post-tax return.
Let us understand the calculation of STCG tax based on an example. Suppose you invested Rs. 50,000 in a debt fund two years back. In the last two years, let us say that the interest rates have declined, causing an increase in the value of debt securities.
Today, the value of your investment is Rs. 55,000. You decide to sell it and earn Rs. 5,000 capital gains. Since you have held this investment for less than 3 years, you have to pay STCG tax on it. The rate of tax on STCG is the same as the rate of tax for your income slab.
Suppose your annual income is higher than Rs. 12 lakhs and equal to or less than Rs. 15 lakhs. In this case, you are in the 20% tax category. The same tax rate will apply to the STCG you have earned as well.
Therefore, you will have to pay 20% of Rs. 5,000 as STCG tax, which amounts to Rs. 1,000. However, suppose your annual income is up to Rs. 3 lakhs. In this case, you do not have to pay any income tax nor do you have to pay any tax on your STCG.
To calculate STCG tax on debt funds for any investor. All he has to know is which slab rate he falls under. He has to apply the same tax rate for the STCG he has earned in a financial year. It is so simple that he does not have to approach a chartered accountant or a tax expert for it.
That being said, tax laws change from time to time. Typically, an announcement to change tax rates is made as a part of the Union Budget. Therefore, investors should track the changes in tax laws. In case, they find it difficult to calculate STCG tax on their own, they should consult a tax expert.
They ought to know tax laws before they start trading online.
Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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