Assume that you earn 10% return on your debt fund and 8% return on your arbitrage fund. After completion of 1 year you redeem your holdings in the debt funds and in the arbitrage fund. What is the post tax treatment? The arbitrage fund is an equity fund therefore any holding beyond 1 year is long-term capital gains. Effective Budget 2018, long term capital gains on equity are exempt from tax up to Rs.1 lakh and taxed at a concessional rate of 10% after that. If you have not crossed the Rs.1 lakh limit then your post tax returns will almost be the same as your pre tax returns. The debt fund treatment will be a little more complicated. Since the definition of long term in case of debt funds is 3 years, the sale after 1 year will be classified as short term capital gains. Therefore, it will be taxed at the peak rate of 30% (for simplicity we avoid surcharge). That means; your post-tax returns on the debt fund will 7% (10%-3% tax). Thus in post tax terms, the arbitrage fund is definitely more attractive than the debt fund.

Assume that you earn 10% return on your debt fund and 8% return on your arbitrage fund. After completion of 1 year you redeem your holdings in the debt funds and in the arbitrage fund. What is the post tax treatment? The arbitrage fund is an equity fund therefore any holding beyond 1 year is long-term capital gains. Effective Budget 2018, long term capital gains on equity are exempt from tax up to Rs.1 lakh and taxed at a concessional rate of 10% after that. If you have not crossed the Rs.1 lakh limit then your post tax returns will almost be the same as your pre tax returns. The debt fund treatment will be a little more complicated. Since the definition of long term in case of debt funds is 3 years, the sale after 1 year will be classified as short term capital gains. Therefore, it will be taxed at the peak rate of 30% (for simplicity we avoid surcharge). That means; your post-tax returns on the debt fund will 7% (10%-3% tax). Thus in post tax terms, the arbitrage fund is definitely more attractive than the debt fund.