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nism-series-va-section-50aa-debt-mutual-fund-taxation-rules[ MUTUAL FUND DISTRIBUTORS ]

An investor purchases units in a corporate bond debt mutual fund (investing 85% in domestic corporate debt) on 10th May 2023 and redeems them on 20th August 2026 (holding period = 39 months). How will the realized capital gains be taxed under the Income Tax Act?

[ A ]Long-Term Capital Gains taxed at 20% with indexation benefits.

[ B ]Deemed Short-Term Capital Gains under Section 76, taxed at the investor's applicable marginal income tax slab rate.[ CORRECT ]

[ C ]Long-Term Capital Gains taxed at 12.5% without indexation.

[ D ]100% tax-free under Section 11 (the erstwhile Section 10(23D)).

Takeaway

Specified Mutual Funds (>65% debt bought after 01-04-2023) are deemed short-term capital assets under Section 76 of the Income-tax Act, 2025 (the erstwhile Section 50AA of the Income-tax Act, 1961), taxed at personal slab rates.

Derivation

The statutory test under Section 76 of the Income-tax Act, 2025 (the erstwhile Section 50AA of the Income-tax Act, 1961) (Finance Act 2023) is that a 'Specified Mutual Fund' holds not more than 35% in domestic equity shares — this corporate bond fund's 85% allocation to corporate debt clears that threshold with room to spare. Because the units were acquired on 10 May 2023 (after the 1 April 2023 cut-off), every redemption is deemed to arise from a short-term capital asset, irrespective of how long it was actually held. The 39-month holding period here would have earned indexed 20% LTCG treatment under the pre-2023 debt fund rules, but Section 76 overrides holding-period logic entirely: gains are added to taxable income and taxed at the investor's marginal slab rate, with no indexation benefit available.

Why the others fail

A — Long-Term Capital Gains taxed at 20% with indexation benefits.

This is the pre-Finance Act 2023 debt fund regime; indexed 20% LTCG on redemption after 36 months no longer applies to units of a Specified Mutual Fund acquired on or after 1 April 2023.

C — Long-Term Capital Gains taxed at 12.5% without indexation.

12.5% unindexed LTCG under Section 197 applies to long-term capital assets like unlisted bonds and hybrid funds, not to Specified Mutual Funds, which Section 76 deems short-term outright.

D — 100% tax-free under Section 11 (the erstwhile Section 10(23D)).

Section 11 of the Income-tax Act, 2025 (the erstwhile Section 10(23D) of the Income-tax Act, 1961) shields the mutual fund trust's own portfolio income from tax; it says nothing about what an investor owes when redeeming units at a gain.