How debt mutual funds are taxed now (Specified Mutual Fund, s.50AA)

You redeemed a debt fund this year, or you plan to. Your broker statement shows a "capital gain", and you want to know which rule taxes it. Older articles on debt funds are often out of date. This article walks through what the law says now for assessment year (AY) 2026-27, which is financial year (FY) 2025-26.

The short version

• Whether your fund is taxed under a special rule depends on one test in section 50AA of the Income-tax Act, 1961: is it a "Specified Mutual Fund"?
• If it is, and you bought the units on or after 1 April 2023, the gain is deemed a short-term capital gain. It does not matter how long you held the units.
• If you bought the units before 1 April 2023, section 50AA does not reach them, because it applies only to units "acquired on or after the 1st day of April, 2023".
• The test for a Specified Mutual Fund was replaced by the Finance (No. 2) Act, 2024 "with effect from the 1st day of April, 2026". Under the usual Finance Act convention, an amendment effective from 1 April 2026 takes in AY 2026-27, so this is the test your FY 2025-26 return is likely to use. The Act's words do not spell out the transfer date, so confirm this with a CA.

What section 50AA says

Section 50AA (Income-tax Act, 1961) opens with the words "Notwithstanding anything contained in clause (42A) of section 2 or section 48". Clause (42A) is the definition of a short-term capital asset, so it is the clause that normally decides whether a gain is short-term or long-term. Section 48 is the section that computes the gain and, in some cases, allows indexation. Section 50AA switches both off for the assets it names.

As substituted by the Finance (No. 2) Act, 2024 (deemed to apply from 23 July 2024), the section applies where the capital asset is "a unit of a Specified Mutual Fund acquired on or after the 1st day of April, 2023 or a Market Linked Debenture", or an unlisted bond or unlisted debenture transferred, redeemed or maturing on or after 23 July 2024.

For those assets, the full value of consideration received, reduced by the cost of acquisition and by the expenditure incurred wholly and exclusively in connection with the transfer, redemption or maturity, "shall be deemed to be the capital gains arising from the transfer of a short-term capital asset".

In plain words, the gain is the sale value less the cost and the transfer expenses, and it is always short-term. There is no waiting period that turns it into a long-term gain, and there is no indexation of cost.

The section also carries a proviso: no deduction is allowed in computing the capital gain for any securities transaction tax (STT) paid under Chapter VII of the Finance (No. 2) Act, 2004. That proviso sits after the portion the 2024 Act replaced, so the amending text leaves it in place. The Income-tax Act, 2025 repeats the same bar in section 76(4). Check it in the full current section before you rely on it.

The gain is added to your total income and taxed through your regime's slabs. This article states no rate number, because the rate depends on your slabs and regime. Confirm with a CA that no special rate applies to your case.

Who is a "Specified Mutual Fund" for AY 2026-27

This is the part that changed, so keep the two tests apart.

Old test. When section 50AA was inserted by the Finance Act, 2023, a Specified Mutual Fund was a Mutual Fund "where not more than thirty five per cent. of its total proceeds is invested in the equity shares of domestic companies". That wording was the law until the replacement took effect, so it governs periods before 1 April 2026 (assessment years up to AY 2025-26, that is FY 2024-25 and earlier).

New test. The Finance (No. 2) Act, 2024 replaced clause (ii) of the Explanation "with effect from the 1st day of April, 2026". The substituted clause says that "Specified Mutual Fund" means:

• (a) a Mutual Fund, by whatever name called, which invests more than sixty-five per cent of its total proceeds in debt and money market instruments; or
• (b) a fund which invests sixty-five per cent or more of its total proceeds in units of a fund referred to in (a).

Two provisos follow. First, the percentage is "computed with reference to the annual average of the daily closing figures". So one day's portfolio does not decide it. Second, "debt and money market instruments" include any securities "classified or regulated as debt and money market instruments by the Securities and Exchange Board of India".

What this means for you:

• The test is now about how much the fund holds in debt and money market instruments, not how little it holds in equity. A fund can hold some equity and still be a Specified Mutual Fund if its debt and money market holding is more than 65 per cent on the annual average.
• A fund of funds that puts 65 per cent or more of its money into units of such a debt fund is also caught, under (b).
• A hybrid or mixed fund needs a check against the annual-average test. Do not assume from the fund's name; ask the fund house for the annual-average split.
• The new definition takes effect from 1 April 2026 and the old one applied before. AY 2026-27 begins on 1 April 2026, so the new definition is likely the one for a FY 2025-26 redemption. The Act's text does not say so in terms; ask your CA to confirm, especially for a fund near the dividing line (for example a hybrid fund holding 35 per cent or less in equity but not more than 65 per cent in debt).
• The opening words of section 50AA (units acquired on or after 1 April 2023) are deemed to apply from 23 July 2024. Only the definition of Specified Mutual Fund waits for 1 April 2026.

Units bought before 1 April 2023

Section 50AA names a Specified Mutual Fund unit "acquired on or after the 1st day of April, 2023". Units acquired earlier are outside those words. For them, the ordinary rules apply.

Is the gain long-term? The opening words of clause (42A) of section 2 (Income-tax Act, 1961), as amended by the Finance (No. 2) Act, 2024 from 23 July 2024, read "twenty-four months" in place of "thirty-six months". So a debt fund unit that is not listed on a stock exchange and was held for more than twenty-four months before transfer gives a long-term gain. The Finance (No. 2) Act, 2024 also changed the provisos to clause (42A), so if your units are listed on a stock exchange (for example some exchange-traded debt funds), read clause (42A) as it now stands before you decide the period.

What rate applies? For a long-term gain from a transfer on or after 23 July 2024, section 112(1) (Income-tax Act, 1961) taxes the long-term capital gains of a resident individual or HUF "at the rate of twelve and one-half per cent for any transfer which takes place on or after the 23rd day of July, 2024". The older rate in the same clause, twenty per cent, applies only to transfers before that date.

Is there a grandfather benefit with indexation? The second proviso to section 48 (the indexation proviso) was amended by the Finance (No. 2) Act, 2024 so that it applies where the long-term gain arises from a transfer "which takes place before the 23rd day of July, 2024". The "lower of two taxes" relief in section 112(1) is, in the text open to us, written for "land or building or both" acquired before 23 July 2024. It does not mention units of mutual funds.

So, for a redemption on or after 23 July 2024, the text we checked gives a long-term gain on a pre-April-2023 debt unit at the 12.5 per cent rate, with no indexation and no land-and-building relief. If you read otherwise in an older article, check its date. We relied on the amendment words quoted above, not on the full current text of section 48, so read that section before you file.

Where equity funds sit

Section 112A (Income-tax Act, 1961) deals with long-term gains on equity shares, units of an equity oriented fund and units of a business trust where STT has been paid. It taxes the gain above one lakh twenty-five thousand rupees (₹1.25 lakh) at twelve and one-half per cent for transfers on or after 23 July 2024, and it applies only to those assets.

A debt fund is not an equity-oriented fund, so section 112A is not your section. Do not apply the ₹1.25 lakh exemption to debt fund gains. Broker statements often lump all "long-term capital gains" together, so separate them.

A note on the Income-tax Act, 2025 from tax year 2026-27

The Income-tax Act, 2025 applies from 1 April 2026, which is tax year 2026-27. Your AY 2026-27 return is still under the 1961 Act, so what you file this year follows the sections above. The 2025 Act governs tax year 2026-27 onward.

The mapping table of the Income-tax Department (1961 to 2025) maps section 50AA of the 1961 Act to section 76 of the 2025 Act, which is titled as a special provision for computation of capital gains in case of Market Linked Debenture. Section 76(2)(a) of the 2025 Act again names "a unit of a Specified Mutual Fund acquired on or after the 1st April, 2023 or a Market Linked Debenture". Section 76(1) treats the gains as short-term "irrespective of anything contained in section 2(101) or section 72", and section 76(4) bars any deduction for STT.

The 2025 Act's meaning of "Specified Mutual Fund" in section 76(5)(b) is a Mutual Fund that "invests more than 65% of its total proceeds in debt and money market instruments or a fund which invests 65% or more of its total proceeds in units of such Mutual Fund", with the same annual-average rule. So the 65 per cent test carries over.

Per the same table, clause (42A) of section 2 maps to section 2(101) of the 2025 Act (main rule: twenty-four months) and section 112 maps to section 197 (rate: 12.5%). Read the 2025 Act's own text, not the table alone, for a tax year 2026-27 redemption.

Step by step: how to work out one redemption

• Find the units' purchase date. Units from different dates need separate lots. Funds report this in the capital gains statement.
• Ask whether the fund is a Specified Mutual Fund under the test above, using the annual-average debt and money market percentage. Do this before you apply any rule.
• If it is, and the units were bought on or after 1 April 2023, compute gain as sale value less cost and less expenses of transfer. Treat it as short-term. Add it to your income and tax it at your regime's rates. Do not index the cost.
• If the units were bought before 1 April 2023, test the holding period under clause (42A) of section 2. If long-term, apply section 112, 12.5 per cent for a transfer on or after 23 July 2024. If short-term, normal rates.

What not to do

• Do not apply section 112A or the ₹1.25 lakh exemption to a debt fund.
• Do not call a gain "long-term" because you held the units for several years, if the units were bought on or after 1 April 2023 and the fund is a Specified Mutual Fund.
• Do not depend on a fund's name or category. Check the annual-average percentage.

What to do now

• Next step: List every debt fund redemption in FY 2025-26 with purchase date, sale date and the fund's debt and money market percentage. Authority: section 50AA, Income-tax Act, 1961.
• Deadline: For an individual who is not required to get accounts audited, the return for AY 2026-27 is due under section 139 of the Income-tax Act, 1961. Check the due date for your category on the income tax portal before you file. A belated return under section 139(4) is possible until 31 December.
• Consequence: Wrong classification changes the tax. Section 112 and section 50AA lead to different tax on the same sale.

Have a CA review your facts before you act or file.

FAQs

Does a debt fund held for more than three years get a lower rate now?
Not if the units were bought on or after 1 April 2023 and the fund is a Specified Mutual Fund. Section 50AA treats the gain as short-term whatever the holding period (Income-tax Act, 1961).

Is my hybrid fund a Specified Mutual Fund?
Under the definition effective 1 April 2026, it is if it invests more than sixty-five per cent of its total proceeds in debt and money market instruments, measured on the annual average of daily closing figures. Before that date the test was not more than thirty-five per cent in equity shares of domestic companies. Check the fund's own annual-average figure. The name is not the test.

I bought before April 2023. Does section 50AA apply?
The words of section 50AA reach only units "acquired on or after the 1st day of April, 2023", so it does not. The long-term or short-term question goes to clause (42A) of section 2, and the rate for a long-term gain to section 112.

Can I use indexation on units bought before April 2023?
The indexation proviso to section 48 was amended so that it applies to long-term gain from a transfer taking place before 23 July 2024. For later transfers the text we checked gives no indexation, but we have not read the full current section 48, so read it or ask your CA.

Does the 2025 Act change the answer?
Not the rule. Section 76 of the Income-tax Act, 2025 carries the same Specified Mutual Fund idea for tax year 2026-27 onward, and the 65 per cent test is stated again in section 76(5)(b).

Is securities transaction tax deductible against the gain?
No. Section 50AA, and section 76(4) of the 2025 Act, say no deduction is allowed for STT paid.

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