How Indexation helps in Debt and International Mutual Funds


When you invest in mutual funds, you consider various points like expected returns, goals, time horizon, etc. but unfortunately most investors do not take into consideration tax implication of their mutual funds.

It is important to do so since they affect the overall returns and other decisions like the structure of your portfolio and the timing of your exit.

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How are mutual funds taxed? 

Mutual funds are taxed based on the asset classes they invest in.

There is one set of rules for equity mutual funds and another for debt mutual funds.

For the purpose of taxation, international mutual funds are considered as debt mutual funds.


Additional reading: Click Here to read our complete report on ELSS funds and how they work

Equity mutual funds

An equity mutual fund is a fund that invests primarily in shares of companies.

Since equity mutual funds carry the most risk among all mutual funds, they also have the potential to generate the highest returns.

For a fund to qualify as an equity mutual fund, it needs to invest 65% of its corpus in equities at all times.

Only tax saving mutual funds, also known as elss funds need to invest 80% of its corpus in equities at all times as opposed to 65% for other equity mutual funds.


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Long term capital gains tax better known as LTCG is applied on equity mutual funds when the gains from equity mutual funds held for more than a year are more than 1 lakh.

The LTCG rate is 10%.

Capital gains up to 1 lakh are exempt for taxes.

There is no indexation benefit when calculating LTCG.



Short term capital gains tax better known as STCG is applied on gains from equity mutual funds which are held for 12 months or less.

The STCG rate is 15%.

There is no ceiling benefit in STCG like the 1 lakh ceiling in LTCG.

STCG is charged on from Re 1.



Debt mutual funds

Debt mutual funds invest in government securities, debentures, corporate bonds, etc. unlike equity mutual funds which invests primarily in equity and equity related instruments.

They provide lower returns than equity mutual funds but more safety.

They are less volatile than equity mutual funds and are more suited for short term goals.


Additional reading: Click Here to read our complete report on ESG mutual funds


For debt mutual funds, long term capital gains tax is applied on gains from debt mutual funds held for more than 36 months.

The LTCG rate for debt mutual funds is 20% after indexation.



For debt mutual funds, short term capital gains tax is applied on gains from debt mutual funds held for less than 36 months.

Short term capital gains are added to your income and taxed as per your income tax slab.




Taxes on International mutual funds

International mutual funds are taxed as debt mutual funds.

The taxation rules applicable on debt mutual funds are applicable on international mutual funds too.

It is the same for all international mutual funds irrespective of the geography.

Meaning a US based international mutual fund will be taxed in the same manner as a European, emerging markets or Asia based.


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What is Indexation?

Indexation is a procedure by which the purchase price of an asset is adjusted according to inflation.

Therefore, indexation increases the purchase price of an asset.

This reduces the overall gains and in turn the taxes to be paid as well.

Indexation allows you to adjust the price with respect to the Cost Inflation Index (CII), indexation takes into account inflation.

The Cost Inflation Index (CII) is updated annually by the Government of India.


Understanding Indexation

Let us say that Raj had invested 50,000 on 1st April 2017 in a debt mutual fund.

He redeems the total investment standing at 70000 on 1st June 2020.

The total gain therefore is 20,000.

Since the investment has been held for more than 3 years, Raj can avail the benefit of indexation.

As previously mentioned, the Cost Inflation Index (CII) is updated annually by the Government of India.

Financial Year

Cost Inflation Index









Source: Cost Inflation Index released by the Government annually


The cost inflated purchase price will therefore be:

50000 x    CII of Selling year

                 CII of Purchase year


50000 x    301 = 55330.88



The purchase price now for calculating your LTCG is now 55330.88 instead of 50000.

This reduces your taxable gains from 20,000 to 14,669.12.

You will now be taxed 20% (LTCG on Debt mutual funds) plus any surcharge/cess applicable on 14,669.12 instead of 20,000.


Selling Price

Purchase Price with Indexation

Purchase Price without Indexation




Taxable Gains





The very visible and obvious benefit of Indexation on debt mutual funds is the reduction of your taxable gains but also having the option of making higher gains compared to other fixed income instruments.

This is because traditional fixed income instruments like Fixed Deposits and so on do not have the option of indexation.


The calculations in the above post have been provided in good faith but should not be judged on their accuracy, tax laws are liable to changes and for any query regarding tax calculation one should refer to their tax consultant.



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Disclaimer : While due precaution has been undertaken in the preparation of this article, The Mutual Fund Guide or any of its authors will not be held liable for any investments based on the above article. The above article should not be considered financial advice and has been published only for your perusal. Due credit has been given in case wherever required, in case you feel any part violates any rights then do get in touch with us and we shall get it duly removed.  
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