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Finance minister Arun Jaitley cleared the air around new taxation rules for debt funds that were announced in the budget earlier in July. Though there were fears of retrospective tax—and Jaitley did give some respite to debt funds—the respite isn’t much. If you purchased debt fund units before 1 April 2014 and still hold them, you will have to pay short-term capital gains tax (STCG) if you sell them before three years.

Budget 2014 increased the threshold for claiming long-term capital gains tax (LTCG) in “non-equity funds” to three years, up from a year before. Also, earlier you had a choice of claiming LTCG tax of 10% (without indexation) or 20% (with indexation). Now, the 10% option is gone and the LTCG tax rate for debt funds is a flat rate of 20% (with indexation).

Appeal by industry and government response Though the budget provisions were applicable from 1 April 2014, the Association of Mutual Funds of India (Amfi; the mutual fund industry’s trade body) and the capital markets regulator, Securities and Exchange Board of India (Sebi), appealed to the finance ministry to excuse open-ended debt funds from the rule as well and not impose these taxes retrospectively. A retrospective tax means that the tax becomes applicable from a preceding date instead of a future date. Note that budget 2014 was presented on 10 July.

Jaitley did not concede to all the demands made by Amfi, but gave a small respite. Withdrawals from debt funds between 1 April and 10 July will be considered under the old taxation rules. If they were held for more than a year, then they will be considered long-term and taxed at a rate of 10% (without indexation) or 20% (with indexation). Similarly, the old threshold for claiming the LTCG tax for debt funds, if held for a year, will apply. They would be taxed at income tax rates if they are held for a period of less than a year. Since Jaitley specified only about withdrawals made between 1 April and 10 July, it means that that the new rules will apply to all redemptions made after 10 July or any other purchase made that you still hold on to.

The repercussions

So, if you had purchased debt fund units before 1 April 2014 and sold them after 10 July 2014, the new budget rules will apply to them. These rules will apply to all “non-equity funds”. In other words, they will apply to not just your debt funds, but also your international funds and gold funds. This also spells bad news for double-indexation beneficiary fixed maturity plans if you bought them in the months leading up to 31 March 2014. Most of these FMPs are launched for a period of little over one year and are bound to come up for redemption within a year from now. Many fund houses have now started to rollover one-year FMPs and are giving investors the option to stay invested till they complete three years.