NISM-Series-X-B: Investment Adviser (Level 2) · Taxation of Debt Products

Taxation of Debt Mutual Funds in India

Updated 11 October 2026 · Fact-checked

Debt mutual fund dividends are taxed at your slab rate. For transfers on or after 1 April 2025 (AY 2026-27 onwards), gains on specified mutual funds (more than 65% in debt and money market instruments) are deemed short-term, taxed at slab rate, with no indexation, whatever the purchase date. Earlier transfers used the older 35% equity test. Check fund type, holding period and transfer date.

Understand Taxation of Debt Mutual Funds

A debt mutual fund earns interest and trading gains on bonds and money market instruments. You, the investor, are taxed in two ways: on income the fund pays you (dividends) and on gains when you redeem or switch units (capital gains).

Dividends (IDCW) are added to your income and taxed at your slab rate. The fund may deduct TDS if the dividend crosses the threshold in the law. Always confirm the current threshold and rate.

Capital gains used to depend on holding period. Before the 2023 change, debt fund units held for more than 36 months were long-term and got indexation. Indexation raises your purchase cost using the Cost Inflation Index, so less gain is taxed.

The Finance Act 2023 inserted Section 50AA. Its original text applied to specified mutual fund units bought on or after 1 April 2023. Such units are treated as short-term capital assets whatever the holding period. Gain is taxed at your slab rate, with no indexation.

The definition of a specified mutual fund has changed:

Earlier test (for transfers before 1 April 2025): a fund investing not more than 35% of its proceeds in equity shares of domestic companies, with units bought on or after 1 April 2023.
Current test: for transfers on or after 1 April 2025 (FY 2025-26, AY 2026-27 onwards), after the Finance (No.2) Act 2024, a specified mutual fund is one that invests more than 65% of its total proceeds in debt and money market instruments. From that point the 1 April 2023 purchase-date condition no longer applies.

So, for transfers on or after 1 April 2025, units of a specified mutual fund are deemed short-term and taxed at slab rate whatever the purchase date. For transfers in earlier years, the 35% equity test and the 1 April 2023 purchase-date condition applied. Older material still mentions the date-based rule, so know which transfer year each version covers.

Funds that are not specified mutual funds follow ordinary capital gains rules. For these, check the transfer date. For transfers on or after 23 July 2024, unlisted non-equity units are long-term only if held more than 24 months. The long-term gain is taxed at a flat 12.5% without indexation. Equity-oriented funds follow separate rules.

Key formulas to remember

Dividend (IDCW) tax: Taxed at investor's slab rate under Income from Other Sources; The fund may deduct TDS above a threshold. Dividend is not exempt in the investor's hands.
Section 50AA gain: Gain = Sale value − Cost of acquisition (no indexation); deemed short-term; tax at slab rate; Applies to specified mutual fund units however long you hold them. For transfers on or after 1 April 2025 it applies whatever the purchase date. For earlier transfers, only units bought on or after 1 April 2023 were covered.
Original specified fund test (earlier years): Equity in domestic company shares ≤ 35% of proceeds; This was the test in the Finance Act 2023, tied to units bought on or after 1 April 2023. It applied to transfers before 1 April 2025. After that it is replaced by a debt-based test, shown in the next item.
Current specified fund test: Debt and money market instruments > 65% of total proceeds; Applies from AY 2026-27 (FY 2025-26), that is, to transfers on or after 1 April 2025, after the Finance (No.2) Act 2024. The purchase-date condition no longer applies from then.
Funds outside Section 50AA, transfer on or after 23 July 2024: Unlisted non-equity units: long-term if held more than 24 months; tax at 12.5% without indexation; Applies to funds that are not specified mutual funds, such as a gold fund of funds. Shorter holding gives short-term gain taxed at slab rate. Add 4% cess; surcharge may apply.
Pre-July 2024 old rule: Long-term if held more than 36 months; 20% with indexation; Know it as history. Old questions and older material still mention it.
Indexed cost: Indexed cost = Cost × CII of year of transfer ÷ CII of year of acquisition; Not available for Section 50AA units or for current long-term debt fund gains.

How to solve Taxation of Debt Mutual Funds questions

Use the same decision path for every debt fund tax question.

1Identify the income: dividend (IDCW) or capital gain on redemption, switch or transfer.
2For dividends, tax at the slab rate and note any TDS. Stop here.
3For gains, check the fund type and the transfer date first. For transfers on or after 1 April 2025, is it a specified mutual fund, investing more than 65% in debt and money market instruments?
4If yes, treat the gain as short-term at slab rate under Section 50AA. Ignore holding period, indexation and purchase date. For a transfer before 1 April 2025, use the older 35% equity test and the 1 April 2023 purchase-date condition instead.
5If it is not a specified mutual fund, check the transfer date and holding period against the rule that applies.
6Compute gain = sale value − cost of acquisition. Use indexed cost only where the question says indexation applies.
7Apply the rate and add 4% cess. Add surcharge only if the question gives it.
8Check the options for the trap: wrong holding period, indexation wrongly allowed, or cess missed.

Quickest way: Fund-type-first shortcut

When to use it: Use this on MCQs that give fund type, holding period and transfer date.

Look at the fund type and transfer date first.
Specified mutual fund (more than 65% in debt and money market instruments) and transfer on or after 1 April 2025? Answer: short-term, slab rate, no indexation, whatever the purchase date.
Transfer before 1 April 2025? Use the older 35% equity test and the 1 April 2023 purchase-date condition.
Not a specified fund? Check the transfer date and holding period against the current rule.
Equity-oriented fund? Leave this topic and use equity fund rules.
Multiply the gain by the rate, then by 1.04 for cess.

Common mistakes in Taxation of Debt Mutual Funds

Giving indexation to specified debt fund units.
You remember the old 36-month rule and apply it by habit.
Fix: Section 50AA removes long-term treatment and indexation for specified mutual fund units. For transfers on or after 1 April 2025 this holds whatever the purchase date.
Thinking a long holding period makes Section 50AA gains long-term.
Most assets change status with time.
Fix: For these units the gain is deemed short-term regardless of holding period.
Using the purchase date to decide whether Section 50AA applies.
You remember the original rule tied to units bought on or after 1 April 2023.
Fix: Check the fund type and the transfer date first. For transfers on or after 1 April 2025, specified mutual fund units (more than 65% debt) are deemed short-term at slab rate whatever the purchase date. The date-based rule applied only to earlier transfers.
Treating dividends as tax-free because the fund already earned the income.
Older rules taxed dividends at fund level through distribution tax.
Fix: Dividends are taxable in the investor's hands at slab rate. TDS is only an advance credit.
Forgetting 4% cess.
You stop at the basic tax.
Fix: Add 4% health and education cess unless the question says to ignore it.
Using equity fund rules for a debt fund with some equity.
You assume any equity exposure means equity taxation.
Fix: Classify by the fund's equity share and the definition in force. A low equity share does not make a fund equity-oriented.

Worked examples

Example 1

Riya is in the 30% slab. She bought units of a specified debt mutual fund on 1 June 2023 and sold them after 4 years. Her gain is ₹2,00,000. Ignoring surcharge, what is her tax?

Show the solution

The transfer is in 2027, after 1 April 2025, and the fund is a specified mutual fund, so Section 50AA applies whatever the purchase date.
The gain is deemed short-term, whatever the 4-year holding.
No indexation. Taxable gain = ₹2,00,000.
Tax at slab rate 30% = ₹60,000.
Cess at 4% of ₹60,000 = ₹2,400.
Total = ₹60,000 + ₹2,400 = ₹62,400.

Answer: ₹62,400

Example 2

Arun bought units of an unlisted gold fund of funds on 1 January 2023. It is not a specified mutual fund (it does not invest more than 65% in debt and money market instruments), so Section 50AA does not apply. He sold the units in August 2025 and his gain is ₹1,00,000. Assume a 12.5% long-term rate without indexation, ignore surcharge. Tax payable? Options: (a) ₹10,400 (b) ₹13,000 (c) ₹20,800 (d) ₹31,200.

Show the solution

The fund is not a specified mutual fund, so Section 50AA does not apply and ordinary capital gains rules are used. Note that a specified debt fund bought on the same date and sold in August 2025 would be short-term under Section 50AA.
Transfer is after 23 July 2024. Unlisted non-equity units are long-term if held more than 24 months.
Holding period is about 31 months, more than 24 months, so the gain is long-term.
Indexation is not available. Taxable gain = ₹1,00,000.
Tax at 12.5% = ₹12,500.
Cess at 4% of ₹12,500 = ₹500.
Total = ₹12,500 + ₹500 = ₹13,000.

Answer: (b) ₹13,000

Exam tips

Start every gain question with the fund type. Whether it is a specified mutual fund (more than 65% debt) decides if Section 50AA applies.
Read the options for the old rule traps: 36 months, 20% and indexation.
Remember that dividends are taxed at slab rate in the investor's hands.
Do not mix up debt fund and equity fund rules. Check fund type before choosing the rate.
Wrong answers cost 25% of the question's marks, so skip a question if you cannot tell which rule applies.

Practice questions from Taxation of Debt Products

Taxation of Debt Mutual Funds in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Taxation of Debt Mutual Funds: frequently asked questions

What is Section 50AA?

Section 50AA deems the gain on transfer of specified mutual fund units to be short-term, whatever the holding period, taxed at your slab rate. Its original text applied only to units acquired on or after 1 April 2023. For transfers on or after 1 April 2025 (AY 2026-27 onwards), a specified mutual fund is one investing more than 65% in debt and money market instruments, and the purchase-date condition no longer applies.

Do debt funds still get indexation?

Not for specified mutual fund units. For transfers on or after 1 April 2025 this holds whatever the purchase date. For other debt units, indexation has also been removed for transfers from 23 July 2024, with a flat long-term rate instead.

How are debt fund dividends taxed?

Dividends are added to your income and taxed at your slab rate. The fund may deduct TDS if the dividend crosses the prescribed threshold.

Does my holding period matter for specified debt funds?

Not for specified mutual funds. The gain is short-term anyway. For transfers on or after 1 April 2025 the purchase date does not matter either. Holding period still matters for other fund types that are not specified mutual funds.