Tax on Mutual Funds in India

The mutual fund taxation in India refers to the tax treatment of the returns earned from mutual fund investments. This treatment depends mainly on the type of fund and the holding period of the investment. Mutual funds in India are divided into different types, which include equity-oriented, debt-oriented, and other funds. Every category of mutual fund has its own tax regulations and rules. In addition to this, investors may have tax liabilities after they redeem their mutual fund units and achieve capital gains on those redeeming transactions. Investors need to understand how taxes will affect their mutual funds so that they can accurately see their post-tax returns and make informed investment choices based on their financial goals. This article explains what is taxation in mutual fund. 

Mutual Fund Taxation in India – Before vs After 23 Jul 2024

Union Budget of India announced changes to capital gains on mutual funds, which were applicable from 23rd July 2024. It has majorly impacted equity mutual funds, especially long-term capital gains. The table below clearly shows mutual fund taxation.  

Factors to Determine the Tax on Mutual Funds 

Mutual fund taxation can be easily understood when bifurcated into different categories. Below are a few of the factors to determine the tax on mutual funds: 

Type of funds - Mutual funds are taxed differently based on their types, such as Debt Mutual Funds, Hybrid Mutual Fund, Equity-Oriented Mutual Funds, Debt-Oriented Mutual Funds, etc. 

Dividend - A dividend is a part of the profit that is distributed amongst the investors by the mutual fund house. Investors don’t have to sell any assets to receive a dividend. 

Capital Gains - Capital Gain is considered when a capital asset is sold at a higher price than its purchased price at a profit.   

Holding period - The time period an investor holds their mutual funds is considered as holding period. This influences the tax rate on capital gains, lower tax rates are applicable if the holding period is longer. 

How Are Profits Generated in Mutual Funds? 

Investors earn their returns from mutual funds in two primary ways, by either capital appreciation or through income distributions from a mutual fund held over a period of time. The investor's actual return on these gains depends upon the specific fund's investment strategy, asset allocation, as well as overall market performance. 

1. Capital Gains (Capital Appreciation) 

• Capital gains occur when the price of the securities held by the mutual fund appreciates with time. 
• Net Asset Value (NAV) of the fund increases with the increase in the market value of the underlying assets. 
• Capital gains are realised whenever investors redeem their mutual fund units at a higher price than the purchase of Net Asset Value (NAV). 
• These gains are classified as short-term or long-term capital gains depending on the holding period and type of fund and taxed accordingly. 

2. Dividend-Based Income (Income Distribution) 

• There are some mutual funds that distribute a portion of their profits to investors as dividends. 
• Dividends are paid from interest income, dividend income received by the fund, or realised through capital gains. 
• This income is credited directly to the investor’s bank account when declared. 
• Dividend income is taxable in the hands of investors as per their applicable income tax slab rate. 

Taxation on Dividends from Mutual Funds (FY 2025–26) 

Earlier, investors were exempt from tax on dividend income because mutual fund houses paid Dividend Distribution Tax (DDT). However, following the changes introduced in the Union Budget 2020, the DDT was abolished, and dividends are now taxable in the hands of investors. 

For FY 2025–26, dividends received from mutual funds are taxed as follows: 

• The dividend income is added to the investor’s total income, and it is then taxed according to the applicable income tax slab rate. 
• Such income is classified under the head “Income from Other Sources.” 
• For salaried individuals, dividend income must be disclosed under “Income from Other Sources” in ITR-1, if applicable. 

TDS implication 

• Many mutual fund houses deduct tax at 10% if the total dividend paid is exceeding ₹5,000 in a financial year. 
• TDS is applied to both resident and non-resident investors (as per prescribed rates). 
• The deducted TDS can be adjusted against the final tax liability while filing the income tax return. 

Capital Gains Tax on Mutual Funds 

When discussing mutual fund taxation, the capital gains tax on mutual funds refers to the tax imposed on the gains earned when an investor sells or redeems mutual fund units at a value higher than their purchase cost. These gains take place when there is an appreciation in the fund’s Net Asset Value (NAV) over time, and they are taxable under the Income Tax Act, 1961. 

In India, capital gains from mutual funds are not taxed uniformly. The treatment of taxation will largely be influenced by two major aspects, which include the type of mutual fund (equity-oriented, debt-oriented or hybrid funds) and the duration of holding the investment. Depending on the length of holding, the gains may be classified as either short-term capital gains (STCG) or long-term capital gains (LTCG) where they incur different tax rates and treatment. 

After understanding what is the tax on mutual funds, this article further explains how much tax on mutual funds investors need to pay, depending on the fund type.  

Taxation by Fund Type 

This section explains mutual fund taxation depending on the type of mutual fund. 

1. Equity-Oriented Mutual Funds (≥65% Indian Equity) 

Equity-oriented mutual funds refer to the funds that invest at least 65% of their assets in Indian equities. This category includes: 

• Large-cap, mid-cap, and small-cap equity funds 
• Sectoral and thematic funds 
• Arbitrage funds 
• Aggressive hybrid funds (if equity allocation is ≥65%) 

The tax on mutual funds for Short-Term Capital Gains (STCG) follows a 20% tax if the holding period is more than 12 months. Whereas for Long-Term Capital Gains (LTCG), it follows a 12.5% tax if the holding period is more than 12 months. There is an annual exemption for the first ₹1.25 lakh of LTCG (across equity shares and equity-oriented funds), which is tax-free.  

2. Debt-Oriented Mutual Funds (≤35% Equity) 

Debt oriented mutual funds primarily invest in fixed-income instruments and include: 

• Liquid and capital market funds 
• Corporate bond and G-Sec funds 
• Floater funds 
• Conservative hybrid funds (with high debt allocation) 

The tax implications of mutual funds here depend on the purchase date of units. If the units are bought on or after 1 April 2023 then all these situations may take place:  

• All gains are taxed at the investor’s income tax slab rate 
• Holding period is irrelevant 
• No LTCG gain and no indexation 

If the units are bought on or before 31^st march 2023, then these situations will take place:  

Example (Debt Fund): 
Let’s say an  investor in the 30% tax slab invests ₹10,00,000 in a corporate bond fund in February 2023. 

• Sold in August 2025 (after 30 months): LTCG @12.5%, no indexation. 
• If the same investment was made in May 2023, even after 5 years, gains would still be taxed at the 30% slab rate. 

So the debt funds bought after April 2023 are less tax-efficient for investors in higher tax brackets. 

3. Hybrid Funds (35%–65% Equity) 

Hybrid funds balance both equity and debt exposure and include balanced hybrid funds and certain multi-asset funds. 

Tax rules (from 23 July 2024): 

• STCG: Holding period ≤ 24 months → taxed at slab rate 
• LTCG: Holding period > 24 months → taxed at 12.5% (no indexation) 

4. International Funds, Gold Funds & Fund of Funds (FoFs) 

These funds do not meet the 65% Indian equity threshold and are treated as non-equity funds. Examples include: 

• International equity FoFs 
• Gold ETFs and Gold FoFs 
• Multi-asset FoFs 

Tax rules (from 23 July 2024): 

• STCG: Holding period ≤ 24 months → taxed at slab rate 
• LTCG: Holding period > 24 months → taxed at 12.5% (no indexation) 

SIP-Based Mutual Fund Taxation 

Mutual funds invested through SIP are taxed the same way as lump sum investments. Their only significant difference is that each SIP instalment should be considered individual investment in terms of taxation. The following are the main tax regulations of SIPs:  

• Instalments which are in equity-oriented funds and have a tenure exceeding 12 months are subject to LTCG, otherwise, they are subjected to STCG.  
• The holding period (24 or 36 months currently in force) is verified individually on each instalment in debt and non-equity funds. 
• During partial redemptions, the FIFO (First-In, First-Out) method is used, meaning the oldest SIP units are considered sold first. 
• The applicable tax rate (20%, 12.5%, or slab rate) depends on the fund category and holding period of each instalment. 
• Dividend payouts from SIP investments are taxed separately at the investor’s income tax slab rate, with TDS applicable where relevant. 

How to Calculate Tax on Mutual Fund Redemption? 

Below are a few of the steps to calculate tax on mutual fund redemption: 

Step 1: Identify the Type of Fund and Holding Period 

Step 2: Calculate the Gains 

Step 3: Apply the Relevant Tax Rate 

Formula: Capital Gain = Redemption Price – Purchase Price 

Please note: Refer to the above table for applicable tax rates and calculations. 

Disclaimer: All investments are subject to market risks, economic conditions, regulatory changes, and other external factors. Returns are not guaranteed and may vary based on market performance and investment tenure. Investors should assess their risk of tolerance and financial objectives, conduct their own research, and consult a qualified financial advisor before making any investment decisions.     

Conclusion 

Tax on mutual funds in India depends majorly on the type of fund, holding period, and the date of investment, especially after the changes effective from 23 July 2024. Equity-oriented funds have relatively favorable long-term taxation, while debt and non-equity funds now follow simplified but less indexation-friendly rules. The taxation of capital gains, dividends, SIP instalments and the timing of redemption will assist investors in determining their actual after-tax returns. Tax planning and compliance can become far more manageable by using a trusted stock market trading app to monitor investments, time of holding, and realised gains.