Mutual funds have emerged as a preferred investment and wealth creation vehicle over the last few years in India. The returns from these can be in the form of dividends and capital gains when they are sold.
The tax on mutual funds varies as per the holding period and depending on the kind of funds you are investing in.
Here is a complete explanation of how mutual funds taxed in India.
Table of Contents
What are Mutual Funds?
Mutual funds are an investment vehicle made up of a pool of money collected from a number of investors to purchase securities. Investing in these funds is the easiest way to grow your wealth.
You can choose a fund scheme based on your financial goal and start investing to achieve the goal.
Also Read: List of Banks in India
Tax on Mutual Funds – How mutual funds are taxed in India
To understand the taxation on mutual funds in India, you must first know the common types of funds. And then, you must understand how the holding period of a fund can be short term or long term.
Types of Mutual Funds
Five common types of funds based on the asset type and fund characteristics
1. Equity Funds
Equity funds invest predominantly in equities (stocks of companies). Their main objective is wealth creation or capital appreciation.
They aim to grow faster than money market fund. They are best for long term investments.
2. Debt Funds
Debt funds invest in fixed return generating securities such as government securities, treasury bills, corporate bonds, money market instruments, and other debt securities.
They are much safer than equity funds but the returns are also lower than the returns of equity funds.
3. Balanced Funds
Balanced funds invest in a mix of equities and fixed income-generating securities. They are also known as hybrid funds. They are suitable for investors who have a less-risk appetite.
4. ELSS – Tax Saving Funds
ELSS (Equity Linked Saving Scheme) is an open-ended equity mutual fund with a tax benefit. They are popularly known as tax-saving funds.
An ELSS gives you tax exemption benefits of up to Rs. 1.5 lakh under Section 80C. ELSS has a lock-in period of three years.
5. SIPs (Systematic Investment Plans)
SIP (Systematic Investment Plan) is a way of investing money in mutual funds. It allows you to invest a fixed amount at a regular interval for a fixed period of time. SIP can be monthly, quarterly or yearly.
Holding Period of Mutual Funds
The holding period is the length of time for which you stay invested in them. The holding period can either be short term or long term.
Now let’s take a look at the following table to understand the holding period for different types of funds.
| Types of Fund | Short-Term Holding | Long-Term Holding |
| Equity Fund | Less than 1 year | 1 year and more |
| Balanced Fund | Less than 1 year | 1 year and more |
| Debt Fund | Less than 3 years | 3 years and more |
Taxation of Mutual Funds
As mentioned above, tax on mutual funds depends on the holding period and type of fund. Let’s take a look at the rate of tax on mutual funds in India.
Equity Funds
There are different categories under equity funds. Taxation on all these categories calculated in a similar manner. They are large-cap, large & mid-cap, multi-cap, mid-cap, small-cap, balanced, sectoral/thematic, ELSS (tax saving) etc.
Below are the two types of taxes on equity fund depending upon the length of time for which you stay invested.
Long-Term Capital Gains (LTCG) Tax
Long-term capital gains on equity fund of up to Rs 1 lakh are tax-free but you have to pay 10% tax on LTCG above Rs 1 lakh without the benefit of indexation.
Short-Term Capital Gains (STCG) Tax
Short-term capital gains from equity fund, if you redeem your units within one year, are taxed at 15%.
Debt Funds
There are 16 different categories under debt funds. Taxation on all these categories is calculated in a similar manner.
The following are the two types of taxes on debt fund depending upon the holding period of the fund.
Long-Term Capital Gains (LTCG) Tax
Long-term capital gains on debt funds taxed at 20% with indexation benefit. Indexation is a legitimate method of factoring in the rise in inflation between the time you bought debt fund units and the time you sell them.
This way, indexation helps you to save tax on gains from debt fund.
Short-Term Capital Gains (STGC) Tax
Short-term capital gains from debt fund added to your income and taxed according to your income tax slab.
Balanced Funds
Balanced funds are equity-oriented hybrid fund and invest at least 65% of their assets in equity and equity related instruments. This is why they have the same tax structure as equity fund.
Long-Term Capital Gains (LTCG) Tax
Long-term capital gains on balanced funds of up to Rs 1 lakh are tax-free but you have to pay 10% tax on LTCG above Rs 1 lakh without indexation.
Short-Term Capital Gains (STCG) Tax
Short-term capital gains from balanced fund, if you redeem your balanced fund units before 12 months then taxed at 15%.
ELSS – Tax Saving Fund
ELSS is one of the best investment options to save tax under Section 80C of the Income Tax Act 1961. You can invest in ELSS and claim a tax deduction of up to Rs 1.5 lakh in a financial year.
These are diversified equity funds where most of the corpus invested in equity and equity-related products.
ELSS has a lock-in period of three years. When you redeem after 3 years, the long-term capital gains (LTCG) tax will be applied similar to equity fund.
Long-term capital gains on ELSS tax saving funds of up to Rs 1 lakh are tax-free but you have to pay 10% tax on LTCG above Rs 1 lakh without the benefit of indexation.
SIPs (Systematic Investment Plans)
Systematic Investment Plan is a way of investing money in mutual funds. It allows you to invest a fixed amount at a regular interval for a fixed period of time. SIP can be fortnightly, monthly, quarterly or yearly.
The returns from SIPs taxed as per the holding period and the types of funds you are investing in. For the taxation, each SIP installment considered as a fresh investment and gains on them taxed separately.
Tax on Mutual Funds
Taxation of mutual funds will be as below
| Taxation of Mutual Funds | |||
| Types of Funds | Holding Period | ||
| Less than 1 year | 1 – 3 years | More than 3 years | |
| Equity Funds | 15% tax applicable | 10% tax applicable on LTCG above Rs 1 lakh | 10% tax applicable on LTCG above Rs 1 lakh |
| Balanced (Hybrid) Funds | 15% tax applicable | 10% tax applicable on LTCG above Rs 1 lakh | 10% tax applicable on LTCG above Rs 1 lakh |
| Debt Funds | Taxed as per income tax slab | Taxed as per income tax slab | 20% tax applicable on LTCG with indexation benefit |
| ELSS | ELSS has a lock-in period of 3 years from the date of investment | 10% tax applicable on LTCG above Rs 1 lakh | |
| SIPs | Each SIP installment considered as a fresh investment and gains on them taxed separately as per the above table | ||
Tax on Dividends from Mutual Funds
Dividends from equity funds are tax-free in your hands. However, they are paid to you after deducting a dividend distribution tax (DDT) of 11.648% (Dividend tax 10% + Surcharge 12% + Cess 4%) which effectively reduces the in-hand return for you.
Dividends from debt funds are also tax-free in your hands. However, they are also paid to you after deducting a dividend distribution tax of 29.12% (Dividend tax 25% + Surcharge 12% + Cess 4%) which reduces the in-hand return for you.
Securities Transaction Tax (STT)
An STT (Securities Transaction Tax) of 0.001% is also levied by the fund house when you sell your equity fund or balanced fund units. There is no STT applicable to the sale of debt fund units.
Final Thoughts
Now you know that tax on mutual funds depends on the holding period and type of funds. Holding period can be both short-term and long-term.
The mutual funds became more tax-efficient if you stay invested for a longer duration. The tax on LTCG is comparatively lower than the tax on STCG.
Also, note that the LTCG for equity funds up to Rs. 1 lakh in a year is tax-free. Only LTCG above that limit will be taxed.
Note: This post was originally published on October 14, 2018 and has been completely updated for accuracy and comprehensiveness.
Tax on Mutual Funds – How mutual funds are taxed in India
Related post: What is mutual fund | Types of mutual funds
Related post: How to invest in mutual funds?
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