Indexation (Debt - Pre-2023)

The benefit that vanished

For years, indexation was the single biggest reason wealthy Indians parked money in debt mutual funds rather than bank fixed deposits. The idea was simple: if you held a debt fund for more than three years, the government let you inflate your original purchase price using the Cost Inflation Index (CII) before calculating capital gains. Because inflation pushed up your notional cost, your taxable gain shrank dramatically, and the long-term rate was then 20% on that reduced figure. An FD, by contrast, was taxed at your full slab rate every year on the interest.

This made debt funds an after-tax winner for anyone in the 30% bracket. Investors routinely held for just over three years to convert slab-rate income into a lightly taxed long-term gain.

What changed in 2023

The Finance Act 2023 removed this. For units of debt funds (those with 35% or less in equities) purchased on or after 1 April 2023, all gains are now treated as short-term and taxed at your slab rate, no matter how long you hold. Indexation is gone for these.

There is a wrinkle. Units bought before 1 April 2023 retain long-term treatment, but Budget 2024 changed even those: from 23 July 2024, such legacy long-term gains are taxed at a flat 12.5% without indexation rather than 20% with it.

Why it still matters

Understanding indexation explains why post-2023 debt-fund advice shifted. Many investors now compare debt funds purely on returns versus FDs and arbitrage funds (still equity-taxed), since the tax edge is largely gone. For older holdings, knowing whether they sit pre- or post-April 2023 decides the tax you owe, so it pays to check your folio's purchase dates before redeeming. The episode is also a reminder that tax rules drive investment behaviour as much as returns do, and that a benefit taken for granted can be withdrawn at a single Budget.