Tax on Mutual Funds

Q: Are there any tax implications for switching between mutual funds?

Yes. If an investor wishes to switch mutual fund schemes, they are obligated to pay taxes, as switching schemes is considered an act of redeeming the investments. Even a switch between a "Dividend" and "Growth" plan within the same scheme is treated as a redemption and is taxable. Schemes can be switched by redeeming units and investing the amount in another scheme or by requesting the fund house to switch schemes.

Q: Where can I find it possible to avoid capital gains tax tickets?

While you cannot avoid capital gains tax, you can minimise it through efficient tax planning. For instance, Long-Term Capital Gains (LTCG) on equity funds are taxed at a lower rate of 12.5% compared to the 20% rate for Short-Term Capital Gains (STCG). Additionally, equity-oriented LTCG is exempt from tax for gains up to ₹1.25 lakh per financial year. You can also use "Tax Loss Harvesting" to offset your capital gains against realised losses to reduce your overall tax liability.

Q: Can I claim tax deductions on investments in mutual funds?

Under the Old Tax Regime, investments made in Equity Linked Savings Schemes (ELSS) qualify for a deduction under Section 80C, with a maximum limit of ₹1.5 lakh per financial year. However, if you have opted for the New Tax Regime (which is now the default regime), no deductions are available for ELSS investments.

Q: Are mutual fund taxes payable every year?

No. You are only liable to pay capital gains taxes when you sell or switch your holdings. However, dividend income (IDCW) is added to your taxable income and is payable every year as per your income tax slab. If your dividends from a single mutual fund house exceed ₹10,000 in a financial year, a 10% TDS (Tax Deducted at Source) will be applied.

Q: What is Tax Harvesting in mutual funds?

Tax harvesting refers to the process of selling units to derive gains till the tax-exempt limit and re-investing the gains. For instance, in the case of equity funds, there may be a provision to exempt gains up to ₹1.25 lakh per annum. The investor may utilise the exempt limit for making gains and resetting the cost base of the investment.

Q: Is it possible to avoid capital gains tax?

While completely escaping tax is not always feasible, it can certainly be minimised through various strategies. Leveraging the tax-free limit, holding assets for a longer period, and properly planning for withdrawals are some methods to minimise taxation. For instance, gains from stocks amounting to ₹1 lakh in a financial year may not necessarily require taxation.

Q: How to calculate tax on mutual fund redemption?

The computation process begins by calculating the gain. This involves subtracting the cost price from the selling price. The next step is determining the holding period to identify whether it falls under short-term or long-term classification. Following this, the respective tax rates are applied to compute the taxes payable. In the case of SIP investments, each instalment is considered individually.

•6 min read•by Angel One

Understanding how taxes will affect your gains in mutual funds is important because it helps you exit wisely. This knowledge will ensure you do not face any surprises upon the sale of units.

Share

Tax regulations may influence the final amount that reaches you through investment. Mutual funds' taxation is dependent on the type of fund, period of investment, and type of income. Investors tend to consider the income aspect but ignore the tax implications. Taxation of returns varies depending on the fund type, which means that understanding basic taxation of equity, debt, and hybrid mutual funds helps you make sound decisions before buying and exiting.

Key Takeaways

● Mutual fund taxation depends on fund type, holding period, and income type, impacting overall returns and exit decisions.

● Equity, debt, and hybrid funds follow different tax rules, making it important to align investments with tax efficiency.

● SIP investments are taxed individually using the FIFO method, with each instalment having its own holding period.

● Proper tax planning, including understanding LTCG limits and slab rates, helps reduce tax burden and improve net returns.

What is The Tax on Mutual Funds?

Before navigating the complexities of mutual fund taxation, it is essential to distinguish between the two primary investment structures: the Growth Plan and the IDCW (Income Distribution cum Capital Withdrawal) Plan. While mutual funds are subject to daily market volatility, they remain a popular vehicle for long-term wealth creation. Understanding how your chosen plan handles returns is the first step in managing your tax liability.

Under the IDCW plan, formerly known as the "dividend" plan, the fund house may periodically distribute profits to investors at its discretion. These payouts are not guaranteed, nor are they derived from short-term market gains. Critically, any IDCW received is taxable in the hands of the investor based on their specific income tax slab. In contrast, the Growth plan reinvests these profits back into the fund, allowing your capital to compound without triggering immediate tax events.

Taxation is ultimately finalised when you redeem your units. At this point, the difference between your initial investment and the total value at redemption constitutes your capital gains. Understanding these two pathways, receiving periodic payouts or reinvesting for capital appreciation, is fundamental to assessing the tax efficiency of your mutual fund portfolio.

Also Read About: What Is IDCW?

Factors Impacting Tax on Mutual Funds in India

Here are the four factors that determine taxation on mutual fund investment in India:

Type of funds - Taxes are applied to mutual funds based on the type of funds. These funds are equity funds and non-equity funds.
Income distribution - When the NAV (Net Asset Value) units are sold at a higher price than the purchase price, the obtained gains are credited to an Equalisation Reserve Account. Income distributions or capital withdrawals are made at the discretion of its trustees. The amount that the investors receive is considered to be income from other sources and is taxed in the hands of the investor.
Holding period - In India, the holding period determines taxation. For example, a lower holding period calls for higher taxation and vice versa.
Capital gains - Taxation on mutual funds is also based upon capital gains obtained from the appreciation that the investors earn after selling their assets at higher prices.

Taxation of Dividends Offered by Mutual Funds

● Dividend Distribution Tax (DDT): DDT was abolished on 1st April 2020. Companies and AMCs are no longer liable to pay this tax before distribution.

● Current Rule: Dividends (now officially termed IDCW Income Distribution cum Capital Withdrawal) are taxable in the hands of the investor as "Income from Other Sources" at your applicable income tax slab rate.

● TDS Update: Effective from 1st April 2025, the TDS threshold on mutual fund dividends has been increased from ₹5,000 to ₹10,000 per AMC in a financial year. If dividends exceed this, a 10% TDS is deducted for residents.

Taxation of Capital Gains of Equity Funds

● Gains from units held for 12 months or less are taxed at 20% (increased from 15% in July 2024).

● Long-Term Capital Gains (LTCG): Gains from units held for more than 12 months are taxed at 12.5% (increased from 10%).

● Exemption: The annual tax-free limit for equity LTCG has been increased from ₹1 lakh to ₹1.25 lakh per financial year.

Taxation of Capital Gains of Debt Funds

● Post-April 2023 Rules: For units purchased on or after 1st April 2023, all gains are treated as Short-Term Capital Gains, regardless of the holding period.

● Tax Rate: Gains are added to your total income and taxed at your individual tax slab rate.

● Indexation: There is no indexation benefit for units bought after April 2023.

● Older Units: Units purchased before April 2023 qualify as LTCG after 24 months (previously 36) and are taxed at 12.5% without indexation.

Read More About: STCG on Debt Mutual Funds

Taxation of Capital Gains of Hybrid Fund

● Equity-focused hybrid fund (Equity > 65%): Short-term Capital Gains (STCG) are charged at 20%. Long-term Capital Gains (LTCG) for such funds are taxed at a rate of 12.5% on gains that exceed ₹1,25,000 without indexation.

● Balanced/Multi-Asset Hybrid Fund (Equity 35% to 65%): These are now classified separately. Gains on units held for 24 months or less are taxed at the investor's income tax slab rate. Gains on units held for more than 24 months are taxed at 12.5% without indexation.

● Debt-focused hybrid fund (Equity < 35%): For units purchased on or after 1st April 2023, all gains are treated as short-term and taxed as per the investor’s tax slab, regardless of the holding period. Indexation benefits have been abolished for these funds.

Taxation of Capital Gains When Invested Through SIPs

Mutual fund investments via SIP are considered individual investments with their own specific holding periods. If the investor decides to redeem their investment, the First-In-First-Out (FIFO) method is used.

Only the SIP instalments that have completed the required holding period (12 months for equity and 24 months for hybrid) will qualify for LTCG rates (12.5%). Any instalments held for less than that period will be taxed as Short-Term Capital Gains (at 20% for equity or the individual’s tax slab for others). It is important to note that gains are only exempt from tax up to the ₹ 1,25,000 limit for equity LTCG; any amount above this is taxable.

Securities Transaction Tax (STT)

STT is levied on securities trade transactions listed on India’s recognised stock exchanges. An investor is expected to pay STT every time securities are traded on the listed stock exchange. This can be in the form of shares, derivatives, or equity-oriented mutual funds.

For equity-oriented mutual funds redeemed directly through the AMC, STT applies only at redemption. However, when equity fund units (such as ETFs) are traded on a stock exchange, STT may apply to both the purchase and sale transactions.

STT of 0.001% is automatically collected by the stock exchange (for exchange-traded transactions) or the AMC/mutual fund (for direct redemptions) at the time of the transaction and remitted to the government.

Additionally, STT does not apply to the purchase or sale of units in debt mutual funds or liquid funds. Paying STT is a mandatory requirement to qualify for the preferential equity capital gains tax rates (12.5% for LTCG and 20% for STCG).

Tax Rates for Short-Term and Long-Term Capital Gains

Here is a clear, structured table explaining taxation across different mutual fund types based on holding period:

Fund Type	Holding Period for STCG	STCG Tax Rate	Holding Period for LTCG	LTCG Tax Rate
Equity Funds (≥65% equity)	Up to 12 months	15%–20%	More than 12 months	12.5% (above ₹1.25 lakh)
Debt Funds (≤35% equity, post Apr 2023)	Any duration	As per the income tax slab	Not applicable	Taxed as per the slab
Hybrid Funds (Equity-oriented)	Up to 12 months	15%-20%	More than 12 months	12.5% (above ₹1.25 lakh)
Hybrid Funds (Debt-oriented)	Any duration	As per the income tax slab	Not applicable	Taxed as per the slab
Other Funds (35%–65% equity)	Up to 24 months	As per the slab	More than 24 months	12.50%

Conclusion

The importance of taxation cannot be ignored when one is planning the redemption of an investment. However, it needs consideration even during the period when the investment is being made. Various funds have different tax treatment criteria. The same fund may attract differential taxation depending on the duration of holding. A small measure, such as assessing the tax implications before any buy/sell decision, can help you in the long run. There is no requirement for extensive knowledge in the area, but it requires your attention.

Turn insights into action - Open Free Demat Account with Angel One and start investing instantly.

FAQs

Are there any tax implications for switching between mutual funds?

Yes. If an investor wishes to switch mutual fund schemes, they are obligated to pay taxes, as switching schemes is considered an act of redeeming the investments. Even a switch between a "Dividend" and "Growth" plan within the same scheme is treated as a redemption and is taxable. Schemes can be switched by redeeming units and investing the amount in another scheme or by requesting the fund house to switch schemes.

Where can I find it possible to avoid capital gains tax tickets?

While you cannot avoid capital gains tax, you can minimise it through efficient tax planning. For instance, Long-Term Capital Gains (LTCG) on equity funds are taxed at a lower rate of 12.5% compared to the 20% rate for Short-Term Capital Gains (STCG). Additionally, equity-oriented LTCG is exempt from tax for gains up to ₹1.25 lakh per financial year. You can also use "Tax Loss Harvesting" to offset your capital gains against realised losses to reduce your overall tax liability.

Can I claim tax deductions on investments in mutual funds?

Under the Old Tax Regime, investments made in Equity Linked Savings Schemes (ELSS) qualify for a deduction under Section 80C, with a maximum limit of ₹1.5 lakh per financial year. However, if you have opted for the New Tax Regime (which is now the default regime), no deductions are available for ELSS investments.

Are mutual fund taxes payable every year?

No. You are only liable to pay capital gains taxes when you sell or switch your holdings. However, dividend income (IDCW) is added to your taxable income and is payable every year as per your income tax slab. If your dividends from a single mutual fund house exceed ₹10,000 in a financial year, a 10% TDS (Tax Deducted at Source) will be applied.

What is Tax Harvesting in mutual funds?

Tax harvesting refers to the process of selling units to derive gains till the tax-exempt limit and re-investing the gains. For instance, in the case of equity funds, there may be a provision to exempt gains up to ₹1.25 lakh per annum. The investor may utilise the exempt limit for making gains and resetting the cost base of the investment.

Is it possible to avoid capital gains tax?

While completely escaping tax is not always feasible, it can certainly be minimised through various strategies. Leveraging the tax-free limit, holding assets for a longer period, and properly planning for withdrawals are some methods to minimise taxation. For instance, gains from stocks amounting to ₹1 lakh in a financial year may not necessarily require taxation.

How to calculate tax on mutual fund redemption?

The computation process begins by calculating the gain. This involves subtracting the cost price from the selling price. The next step is determining the holding period to identify whether it falls under short-term or long-term classification. Following this, the respective tax rates are applied to compute the taxes payable. In the case of SIP investments, each instalment is considered individually.