Tax on Mutual Funds

If you are a mutual fund investor and have accrued returns on your investments, you may be required to pay income tax on those gains.

Mutual fund taxation in India primarily includes:

• Capital Gains Tax: Either Short-Term Capital Gains (STCG) or Long-Term Capital Gains (LTCG), depending on how long you stay invested
• Securities Transaction Tax (STT), applicable to certain types of mutual fund transactions
• Tax on mutual fund dividends, which are added to total income and taxed as per the investor's income tax slab rate. 

The tax treatment of mutual fund investments varies based on multiple factors, such as 

• Mutual fund type, 
• Holding period, 
• Nature of returns 

This blog will discuss how different categories of mutual funds are taxed in India.

Equity-Oriented Mutual Funds (≥65% in Indian equities)

Equity mutual funds invest at least 65% of their assets in equities. These include sectoral/thematic funds, flexi-cap, mid-cap, large-cap, small-cap, large and mid-cap, multi-cap, ELSS and others. 

Equity Mutual Funds Taxation

Equity MFs are taxed according to the holding period, i.e., 

• Short-Term: Less than 12 months
  
  
• Long-Term: 12 months and more

The ELSS equity mutual fund category comes with a 3-year mandatory lock-in and Section 80C tax benefit. 

After 3 years, gains are treated as Long-Term Capital Gains (LTCG) and taxed at 12.5% (on above ₹1.25 lakh per financial year). 

Tax Benefit: Investments made in ELSS are eligible for deduction up to ₹1.5 lakh per financial year under section 80C, which reduces taxable income under the old tax regime.

Debt Mutual Funds 

Debt mutual funds primarily invest in fixed-income instruments like bonds, treasury bills, and money market securities. These fall under the category of “Specified Mutual Funds” and includes liquid funds, money market funds, corporate bond funds, overnight funds, gilt funds, etc. 

Debt Mutual Funds Taxation

For investments made on or after 1 April 2023:

• Under section 50AA of the Indian Income Tax Act, all capital gains from debt funds are taxed as per the income tax slab rate (without indexation), irrespective of the holding period. 

For investments made before 1 April 2023:

• Sold within 2 years from the date of investment: Taxed as per the income tax slab rate.
• Sold after 2 years from the date of investment: Taxed at 12.5% without indexation

Hybrid Mutual Funds 

The taxation for hybrid mutual fund categories varies according to fund type.

• Hybrid MF [Equity-oriented: ≥65% in Indian equities]

This includes 

• Aggressive Hybrid Fund
• Balanced Advantage Fund/Dynamic Asset Allocation Fund
• Arbitrage Fund
• Equity savings funds

• Hybrid MF [Debt-oriented]

This includes 

• • Conservative Hybrid Funds

For investments made on or after 1 April 2023:

• Taxed as per income tax slab rate, irrespective of the holding period

For investments made before 1 April 2023:

• Sold within 2 years from the date of investment: Taxed as per the income tax slab rate.
• Sold after 2 years from the date of investment: Taxed at 12.5% without indexation

• Multi-Asset Allocation Fund

The taxation for a multi-asset allocation fund depends on the last 12 months' asset allocation and may vary from other funds in the category.

If the equity allocation is ≥65%, it will be taxed as equity-orientated, i.e., STCG at 20% and LTCG at 12.5% on gains above ₹1.25 lakh. For others it will be taxed as non-equity oriented.

• Balanced Hybrid Funds [Non Equity-oriented]

For balanced hybrid funds, 

• Sold within 2 years from the date of investment: Taxed as per the income tax slab rate.
• Sold after 2 years from the date of investment: Taxed at 12.5% without indexation

International (Global) Mutual Funds Taxation

International or global mutual funds are mutual fund schemes that invest primarily in foreign equities, overseas ETFs, or international markets. 

These funds do not qualify as equity-oriented funds under Section 112A, as they don't invest in Indian-listed equities. They are taxed according to the following structure:

• Sold within 2 years from the date of investment: Taxed as per the income tax slab rate.
• Sold after 2 years from the date of investment: Taxed at 12.5% without indexation

Securities Transaction Tax

Along with STCG or LTCG (on equity-oriented funds), investors are also required to pay Securities Transaction Tax, i.e., 0.001%

It is applicable only on equity-oriented funds (≥65% in Indian equities), and that too at the time of redemption (sale). 

Dividend Income From Mutual Funds

Dividend income received from mutual funds is taxed as per the investor’s income tax slab under the head “Income from Other Sources”. Additionally, TDS is deducted if the total dividend received exceeds ₹10,000 in a financial year, as per budget 2025. This limit was ₹5,000 till FY 2024-25. 

Earlier in 2020, dividend distribution tax was applicable; mutual fund houses paid Dividend Distribution Tax (DDT) under Section 115R.

However, from 1 April 2020, DDT has been abolished, and the entire dividend became taxable in the hands of investors.

Conclusion

In conclusion, investors can learn how mutual funds are taxed if they are concerned that their returns from mutual funds will be reduced after paying taxes. They can determine what is advantageous for them by calculating how the tax rules for long- and short-term investments in equity and debt funds differ.

By investing in tax-saver funds, they can reduce their tax obligations and generate corpus. Taxation for a type of fund is the same whether it is purchased in a lump sum or through an SIP (Systematic Investment Plan). However, long-term investments may be more tax-efficient than holding the units for a brief period.