I have noticed that several people are recommending debt funds on the basis that they have better tax treatment than bank fixed deposits. While this is true now, what happens if government changes the rules and brings debt funds on par with fixed deposits?
—Shikhar Mehta
Debt mutual funds do get a preferential tax treatment compared to fixed deposits when it comes to how long-term capital gains are taxed. For such funds, ‘long term’ is defined as a period that is equal to or greater than 3 years. When an investment in one of these funds is held for such a period and then sold, profits from such a sale are taxed at a rate of 20% after indexation (essentially, after the rate of inflation in that holding period) has been factored in. Oftentimes, this tends to bring down the rate of tax to low single digit. In recent years, there have even been instances where the entire capital gains have been taken care of by indexation, whereby no tax was owed by investors.
