Question: I invested in a debt mutual fund in India a few years ago and I'm planning to redeem the units after holding them for more than three years. How will the capital gains be taxed?
Answer: The tax treatment for debt mutual funds depends critically on when you purchased the units — there was a major rule change effective April 1, 2023, so this splits into two scenarios:
If you purchased the units on or after April 1, 2023:
Debt funds acquired after 01/04/2023, the capital gains on sale of such Debt Mutual Funds, market linked debentures and Unlisted Bonds or Debentures are always considered short-term and are taxed at normal slab rates — regardless of your holding period. So even after holding for 3+ years, there's no long-term treatment or indexation benefit. The entire gain gets added to your income and taxed at your applicable income tax slab rate.
If you purchased the units before April 1, 2023:
The old rules continue to apply, since debt funds acquired after 01/04/2023 lost this treatment — implying pre-April 2023 units retain long-term status. For these:

Held for more than 36 months → treated as long-term capital gains
Taxed at 20% with indexation benefit — the purchase cost gets adjusted for inflation using the Cost Inflation Index, reducing your taxable gain

Supporting evidence:
title: incometaxindia.gov.in/section-50aa
quote: 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, the full value of consideration received or accruing as a result of the transfer or redemption or maturity of such debenture or unit as reduced by—
(i) the cost of acquisition of the debenture or unit; and
(ii) the expenditure incurred wholly and exclusively in connection with such transfer or redemption or maturity,
shall be deemed to be the capital gains arising from the transfer of a short-term capital asset:
context: Special provision for computation of capital gains in case of Market Linked Debenture
Special provision for computation of capital gains in case of Market Linked Debenture
Following section 50AA shall be inserted after section 50A by the Finance Act, 2023, w.e.f. 1-4-2024:
Special provision for computation of capital gains in case of Market Linked Debenture.
50AA.
Notwithstanding anything contained in clause (
42A
) of
section 2
or
section 48
, 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, the full value of consideration received or accruing as a result of the transfer or redemption or maturity of such debenture or unit as reduced by—
(i) the cost of acquisition of the debenture or unit; and
(ii) the expenditure incurred wholly and exclusively in connection with such transfer or redemption or maturity,
shall be deemed to be the capital gains arising from the transfer of a short-term capital asset:
Provided
that no deduction shall be allowed in computing the income chargeable under the head "Capital gains" in respect of any sum paid on account of securities transaction tax under the provisions of Chapter VII of the Finance (No. 2) Act, 2004 (23 of 2004).
Explanation
.— For the purposes of this section—
(i) "Market Linked Debenture" means a security by whatever name called, which has an underlying principal component in the form of a debt security and where the returns are linked to market returns on other underlying securities or indices and include any security classified or regulated as a market linked debenture by the Securities and Exchange Board of India;
(ii) "Specified Mutual Fund" means a Mutual Fund by whatever name called, where not more than thirty five per cent of its total proceeds is invested in the equity shares of domestic companies:
Provided
that the percentage of equity shareholding held in respect of the Specified Mutual Fund shall be computed with reference to the annual average of the daily closing figures.
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