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Anyone who invests in mutual funds or wants to start investing must know how their profits or gains will be handled. Like most other types of investments, mutual fund gains are taxed when you get them.
Since it’s hard to avoid taxes, it’s wise to learn about tax laws for mutual funds before you begin investing.
In today’s article, we have clarified the ins and outs of mutual fund taxation in India. Let’s begin!
Understanding mutual fund taxation
Investors are often subject to their relevant income tax rate when they sell mutual fund units that they have held for no more than three years.
This kind of gain is known as short-term capital gains. The profits, however, are considered long-term capital gains if held for a period beyond three years.
Learning how mutual funds are taxed might help you handle your investments in an effective manner and lower your total tax expenses. You may also claim tax deductions under certain conditions.
Taxation on capital gain on mutual fund
The type of mutual fund scheme and the holding period determine the applicable tax rate for capital gains on the investments.
Capital gains based on holding period fall into the following groups:
| Mutual fund type | Holding period for short term capital gains | Holding period for long term capital gains |
| Equity funds | Less than 12 months | More than 12 months |
| Debt funds | Less than 36 months | More than 36 months |
| Hybrid fund (equity oriented) | Less than 12 months | More than 12 months |
| Hybrid fund (debt oriented) | Less than 36 months | More than 36 months |
What is STCG in mutual funds?
Short-term capital gains (STCG) are the profits you earn from selling a debt mutual fund unit within three years of purchase or an equity fund unit within one year of purchase. All of your earnings, including such short-term capital gains, are subject to tax at slab rates.
What is LTCG in mutual funds?
If you invest in debt funds with a holding period of three years, you have to pay taxes on the gains, which are called long-term capital gains (LTCG). LTCG for equity funds takes place when the holding period is more than 1 year.
Debt mutual fund taxation
When it comes to taxes, there are two main types of mutual funds: those that focus on equity and those that focus on debt.
In the past, if you invested in debt funds with a holding period of three years, you had to pay taxes on the gains at a rate of 20%. Now, according to the Finance Act 2023, the government has declared that debt funds, along with other types of non-equity mutual funds, would have their capital gains taxed at higher rates.
As per the Finance Bill modifications implemented on March 24, 2023, gains from funds that own less than 35% equity do not qualify for long-term capital gains tax advantages or indexation. You will be subject to income tax on the sale of these units at your regular income rate, regardless of the timing of your sale.
If you invest in debt funds before April 1, 2023, your long-term capital gains will still be eligible for the indexation advantage.
Equity mutual fund taxation
Equity funds are mutual funds that have at least 65% of their assets in stocks. As mentioned above, if you sell your fund units, you will have STCG. Regardless of your tax bracket, you need to pay a flat rate of 15% for such gains.
In the case of LTCG, if your total gains are ₹1 lakh a year, you are not eligible to pay taxes. However, if the LTCG goes over this amount, one needs to pay 10% without any indexation benefit.
Mutual funds tax rate
Below is a chart of the mutual fund capital gains tax applicable to different types of mutual fund schemes before March 31, 2023.
| Mutual fund type | STCG | LTCG |
| Equity funds | 15% | 10% without indexation |
| Debt funds | Slab rate | 20% with indexation |
| Conservative hybrid funds | Slab rate | 20% with indexation |
| Balanced hybrid funds | Slab rate | 20% with indexation |
| Aggressive hybrid funds | 15% | 10% without indexation |
| Funds with more than 35% but less than 65% in equity | Slab rate | 20% with indexation |
Here is a chart of the tax on mutual fund redemption applicable to different types of mutual fund schemes after March 31, 2023.
| Mutual fund type | STCG | LTCG |
| Equity funds | 15% | 10% without indexation |
| Debt funds | Slab rate | Slab rate |
| Conservative hybrid funds | Slab rate | Slab rate |
| Balanced hybrid funds | Slab rate | 20% with indexation |
| Aggressive hybrid funds | 15% | 10% without indexation |
| Funds with more than 35% but less than 65% in equity | Slab rate | 20% with indexation |
Conclusion
When investors figure out how the tax regulations for long- and short-term investments in equity and debt funds are different, they can figure out what is best for them. This not only helps investors expect the actual returns of an investment but also makes proper tax payments.
Additionally, having clear knowledge also helps them get mutual fund tax benefits by investing in tax-saving funds.
FAQs
There is no limit on the amount of investment in mutual funds that is tax-free. However, the tax exemption depends on the type and holding period of the mutual fund scheme. For example, LTCG from equity and equity-oriented hybrid funds is tax-free up to ₹1 lakh per year.
No, TDS is not deducted from mutual funds. The investor has to pay tax on the capital gains at the time of filing income tax returns. However, TDS applies to dividends paid by mutual funds at a rate of 10% for resident investors and 20% for non-resident investors.
No, not all mutual funds are tax-free. The taxability of mutual funds depends on the type and holding period of the scheme. For example, STCG from equity is taxed at 15%, while STCG from debt funds is taxed as per the investor’s income tax slab.
No, tax is not automatically deducted from mutual funds. The investor has to pay tax on the capital gains when filing income tax returns. The mutual fund house may deduct TDS on dividends paid by the scheme at a rate of 10% for resident investors and 20% for non-resident investors.
Yes, SIP returns are taxable. SIP is a mode of investing in mutual funds, and the taxability of SIP depends on the type and holding period of the mutual fund scheme.