How to calculate tax on debt funds?

If you have been investing in debt funds prudently this year or plan to do so, then this post is for you. In this post i will talk about how to calculate tax on your earnings from debt funds.

Yes you heard it right. Earnings on debt funds are taxable, unlike equity funds.

In case you are selling your debt funds in less than a year of purchase, you need to add the earnings to your income for the year, and calculate tax accordingly.

In case you have been holding the fund for more than a year, then it qualifies as a long term capital gain, and the interest is calulated as 20%-inflation adjustment or a at a flat rate of 10%.

Here is an example to explain things better:

Suppose you invest Rs 1,00,000 in a debt fund in Feb, 2004 and earns 40,000 on it in 5 yrs (u sell it in 2009). Now you have the option to

1) Pay a direct flat tax of 10%  on ur earnings i.e. 4000 Rs, or
2) Claim indexation benefit - this means that u pay tax on inflation adjusted gains. the formula is:
                 Value of investment = Amount invested * (Cost inflation indexation of 2009-10/Cost inflation indexation of 2003-04).

In this example the value of investment comes out to be = 1,00,000*632/463=1,36,000 (approx). So you need to pay 20% tax on actual earning - inflation adjusted value (1,40,000-1,36,000) = Rs 800 only.

So calculate your tax using both the methods and pay the lesser amount.

1 comment

justin albert said...

I am so happy to read this. This is the kind of manual that needs to be given and not the random misinformation that's at the other blogs. Thanks for sharing this.

PIC Scheme

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