Government securities (G-Secs) are also known as Gilts. Like any other bond, Gilts also have fixed maturities, during which they pay interest and principal on maturity. Since they are issued by the Government, Gilts have no credit risk at all. However, long term Gilts have high interest rate sensitivity due to their long durations.
How Indexation is applied in debt fund taxation: By applying indexation, the investor is allowed to adjust the purchase price to reflect inflation for capital gains tax. For example - if you invested in a debt fund in FY 2016 at a NAV of Rs 100 and sold it in FY 2020 at a NAV of Rs 130, you will be allowed to adjust your purchase NAV by a factor of 1.137 (ratio of cost of inflation index in FY 2020 and FY 2016) and your adjusted purchase price will be Rs 113.7. Therefore, the tax will be applicable on gain of Rs 16.30 (Rs 130 – Rs 113.70) only. Long term capital gains (held for more than 3 years) in debt funds are taxed at 20% after indexation.
