How are debt funds more tax efficient than fixed deposits? | Value Research Dhirendra Kumar explains how debt funds are more tax efficient than bank fixed deposits
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How are debt funds more tax efficient than fixed deposits?

Dhirendra Kumar explains how debt funds are more tax efficient than bank fixed deposits

Which debt funds would give return in the range of eight to 8.5 per cent over the next three to four years. Also, I would like to know how are debt funds more tax efficient as compared to bank fixed deposits?
- RS Dahiya

I think short duration funds are likely to provide you returns in this range. But returns from mutual funds cannot be guaranteed neither they give you indicative returns. Yes, debt funds are more tax efficient as compared to bank deposits. When you invest in a bank fixed deposit, all your interest is taxed. The interest is added to your income and taxed at the marginal rate. So if you are in the highest tax bracket, your interest income would be taxed at the highest slab, that is 30 per cent. In debt mutual funds, there is no difference if you sell your investment within three years. All the realised gains would be added to your income and taxed at the marginal rate. The only difference here is that, in mutual funds, the gains are taxable only when they are realised on redeeming your investment. However, interest income is taxable on accrual basis every year. It doesn't matter whether you have actually realised the interest or not.

Also, if you redeem your investment in mutual fund after three years, the gains become long-term capital gains and you are allowed to take the indexation benefit. Only the residue gains after subtracting the inflation is liable to tax. That too, at 20 per cent. In case of interest income, the whole amount is taxable.

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