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Impact of new taxation on Debt fund

When it comes to fixed-income assets, debt funds have long been a favourite for tax-efficient investments.   

However, the new taxation regulation that has took effect on April 1, 2023, eliminates this benefit for most debt funds. Debt funds have previously benefited from a much lower effective taxation rate, as the long-term capital gain tax on a debt fund kept for three years or more was only 20% with indexation.  

By allowing investors to increase their original investment at the current inflation rate, this indexation benefit greatly reduced the net gain. 

What are the new tax rules in India for debt mutual funds that come into effect?

Currently, investors in debt funds pay income tax on capital gains based on the income tax slab for a three-year holding term. These funds yield either 20% with benefits from indexation or 10% without indexation after three years. 

So, is the new tax regulation the end of debt investment, particularly for retail investors? 

Possibly not. 

 Mutual funds with less than 35% invested in domestic equities are proposed to be treated as short-term, and the indexation benefits that aid such funds significantly lower tax liability may be removed prospectively, according to the amendments. As a result, the relevant tax rate would be determined by the investor’s income tax bracket. 

The change aims to stimulate growth in bank deposits, which have been failing to keep up with credit demand in recent months, resulting in higher funding costs for lenders.

How will the proposed changes in tax rule impact investors? 

  • Long-term investments in debt-oriented funds will now be taxed in the same way as bank fixed deposits, pushing investors into the stock market and affecting the nascent debt market.  
  • Senior citizens, who are entitled to an 80TTB deduction on fixed deposit interest, will be the most impacted. 
  • The tax deduction may not apply to new investors who invest in debt funds for a short period, as well as to high net worth individuals (HNIs) and corporations whose investment strategy isn’t heavily influenced by tax consequences. 
  • Long-term debt funds may be replaced by other investment choices, such as equity funds, sovereign gold bonds, peer to peer investing, bank fixed deposits, and non-convertible debentures in the debt category.   
  • Banks will profit because they will be able to attract customers with higher interest rates and expand their borrowing and saving book sizes. 
  • Investors will be tempted to choose between risky investments such as equity mutual funds and safer havens such as bank fixed deposits, resulting in fewer options and additional tax income for the exchequer. 


One of the primary motivators for investing in debt, gold, and foreign funds was the indexation advantage. Retail investors, including have a smaller representation in the fixed income group. As a result, high-net-worth people and international clients are more likely to be impacted by the changes.  

Debt funds make up a sizable portion of Indian portfolios and have successfully directed a sizable amount of money into the bond market. However, the liquidity of the Indian bond market has been a persistent problem, which may cause investors to shift their funds to fixed deposits. Long-term investments in debt funds would be most affected by this change. 

The new tax rules have made P2P investments relatively more tax efficient than debt funds, as it allows investors to claim deductions on their income from P2P investments. This makes it an attractive investment option for those looking for higher returns with lower risks. Furthermore, the low costs associated with P2P investing make it even more appealing to investors who are looking for better returns on their investments. 

Start your P2P investment journey today with Monexo.  

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