Income Tax on Mutual Funds in India

What is Tax on Mutual Funds?

Mutual funds are a way to grow your money by investing in a mix of stocks, bonds, or other assets. But you might have to pay tax when you earn from these investments. In India, the tax on mutual funds is the amount you owe to the government on the profits or income you get from your mutual fund investments.

Variables Determining the Taxation for Mutual Funds

How much tax you pay on mutual funds depends on several things. Let’s look at them one by one.

1. Types of Funds

There are two main types of mutual funds:

• Equity Funds: These invest primarily in stocks. The tax rules for equity funds are different.
• Debt Funds: These invest in bonds and other fixed-income instruments. They have their own tax rules.

Knowing the type of fund helps you understand how it will be taxed.

Learn: how to invest in mutual funds.

2. Capital Gains*

The profit is called a capital gain when you sell your mutual fund units for more than what you paid. There are two types:

• Short-Term Capital Gains (STCG):
  • For equity funds: If you sell within 1 year.
  • For debt funds: If you sell within 3 years.
  • Tax Rate: STCG on equity funds is taxed at 20%. For debt funds, it is added to your income and taxed according to your income tax slab.
• Long-Term Capital Gains (LTCG):
  • For equity funds: If you sell after 1 year.
  • For debt funds: If you sell after 3 years.
  • Tax Rate: LTCG on equity funds over ₹1.25 lakh is taxed at 12.5% without indexation. For debt funds, 12.5% without indexation.

How to Calculate Tax on Mutual Fund Redemption

To figure out how much tax you owe when you sell your mutual fund units:

1. Determine the Holding Period: Find out if your gain is short-term or long-term.
2. Calculate the Gain: Subtract the purchase price from the selling price.
3. Apply the Tax Rate: Use the tax rate that fits your situation.

*- Capital Gains Tax Rates as per new rules in Budget 2024.

3. Dividend

Some mutual funds give you dividends and payments from the fund’s earnings. In India:

• Dividends are Taxable: The dividend amount is added to your total income.
• Tax Rate: It is taxed according to your income tax slab rate.

This means the more you earn, the higher the dividend tax you pay.

4. Holding Period

The holding period is how long you keep your money invested in the mutual fund. It affects the tax you pay.

• Equity Funds:
  • Short-Term: Held for 1 year or less.
  • Long-Term: Held for more than 1 year.
• Debt Funds:
  • Short-Term (Purchased before April 1, 2023): Held for 36 months or less.
  • Short-Term (Purchased before April 1, 2023): Held for 24 months or less.
  • Long-Term: Held for more than 3 years.

Understanding your holding period helps you know if your gains are short-term or long-term, which affects the tax rate.

How Do Mutual Funds Generate Profits for Investors?

Mutual funds help investors make money in two main ways:

• Dividends: Some companies share their profits with shareholders by giving dividends. You might receive part of these dividends if your mutual fund holds these companies.
• Capital Gains: When the value of the investments in the mutual fund goes up, you can earn a profit by selling your mutual fund units for more than you paid.

Taxation of Dividends Provided by Mutual Funds

When you get dividends from mutual funds, they are added to your total income. This means you must pay them tax based on your income tax slab. The more you earn, the higher the tax rate you pay on these dividends.

For example:

• If you are in the 10% tax bracket, you pay 10% tax on the dividends.
• If you are in the 20% tax bracket, you pay 20% tax on the dividends.

Explore: What is Dividend Reinvestment Plan?

Taxation of Capital Gains Provided by Mutual Funds

Capital gains are the profits you make when you sell your mutual fund units for more than you bought them. The tax you pay on these gains depends on the type of fund and how long you hold the investment.

Taxation of Capital Gains Provided by Equity Funds

Equity Funds invest primarily in companies’ stocks.

• Short-Term Capital Gains (STCG):
  • Holding Period: If you sell the units within 1 year.
  • Tax Rate: 20% tax on the profit you made.
• Long-Term Capital Gains (LTCG):
  • Holding Period: If you sell the units after 1 year.
  • Tax Rate:
    • Gains up to ₹1.25 lakh in a financial year are not taxed.
    • Gains above ₹1.25 lakh are taxed at 12.5% without indexation.

Example: If you make a profit of ₹1.5 lakh after selling your equity mutual funds held for more than a year, you pay 12.5% tax on ₹25,000 (which is ₹1.5 lakh – ₹1.25 lakh exemption).

Equity-oriented MF (at least 65% corpus invested in Indian stocks)	Prior to Budget 2024	Post Budget 2024
Long-term Capital Gains	10%	12.5%
Short-term Capital Gains	15%	20%

Taxation of Capital Gains Provided by Debt Funds

Debt Funds invest in fixed-income securities like bonds.

• Short-Term Capital Gains (STCG):
  • Holding Period: If you sell the units within 3 years.
  • Tax Rate: The profit is added to your income and taxed according to your income tax slab.
• Long-Term Capital Gains (Only applicable to funds purchased before 1st April 2023):
  • Holding Period: If you sell the units after 3 years.
  • Tax Rate: 12.5% tax without indexation benefits.
• Long-Term Capital Gains (Only applicable to funds purchased after 1st April 2023):
  • Holding Period: If you sell the units after 3 years.
  • Tax Rate: The profit is added to your income and taxed according to your income tax slab.
    • Indexation adjusts the purchase price for inflation, which can lower your taxable gain.

Example: If you are in the 30% tax bracket and make a short-term gain from debt funds, you pay 30% tax.

Taxation of Capital Gains Provided by Hybrid Funds

Hybrid Funds invest in both stocks and bonds.

• Equity-Oriented Hybrid Funds (invest more than 65% in equities):
  • Taxed like equity funds.
  • Follow the same rules for STCG and LTCG as equity funds.
• Debt-Oriented Hybrid Funds (invest less than 65% in equities):
  • Taxed like debt funds.
  • Follow the same rules for STCG and LTCG as debt funds.

Type of Fund	Short-Term Capital Gains STCG	Long-Term Capital Gains LTCG
Equity funds	20% + cess + surcharge	Any gains above Rs 1.25 lakh is taxed at 12.5% + cess + surcharge
Debt funds	Since April 1st 2023, all capital gains are be taxed at the investor’s income tax slab rate.	-12.5% (If purchased before 1st April, 2023) – Investor’s income tax slab rate (If purchased on / after 1st April 2023)
Hybrid equity-oriented funds	20% + cess + surcharge	Any gains above Rs 1.25 lakh is taxed at 12.5% + cess + surcharge
Hybrid debt-oriented funds	Since April 1st 2023, all capital gains are be taxed at the investor’s income tax slab rate.	-12.5% (If purchased before 1st April, 2023) – Investor’s income tax slab rate (If purchased on / after 1st April 2023)

Tax on Mutual Fund Redemption 2024

Type of Mutual Fund	Short-Term Capital Gains STCG	Long-Term Capital Gains LTCG
Equity Funds	20% + cess + surcharge	Up to Rs 1.25 lakh a year is tax-exempt. Any gains above Rs 1.25 lakh are taxed at 12.5% + cess + surcharge
Debt funds	Taxed at the investor’s income tax slab rate From April 1st 2023, all capital gains will be taxed at the investor’s income tax slab rate.	Until March 31st 2023: 12.5% + cess + surcharge From April 1st 2023: As per Income Tax Slab Rates
Hybrid Fund- Equity Oriented	20% + cess + surcharge	Up to Rs 1.25 lakh a year is tax-exempt. Any gains above Rs 1.25 lakh are taxed at 12.5% + cess + surcharge
Hybrid Fund- Debt Oriented (Until 31st March 2023)	Taxed at the investor’s income tax slab rate From April 1st 2023, all capital gains will be taxed at the investor’s income tax slab rate.	Until March 31st 2023: 12.5% + cess + surcharge From April 1st 2023: As per Income Tax Slab Rates

Tax on SIP Investments

A Systematic Investment Plan (SIP) lets you regularly invest small amounts in mutual funds. When it comes to taxes, each SIP investment is considered separately. Here’s how the tax on mutual funds applies to SIPs:

• Equity Funds:
  • Short-Term Capital Gains: If you sell units within 1 year, the gains are taxed at 20%.
  • Long-Term Capital Gains: Selling after 1 year means gains over ₹1.25 lakh are taxed at 12.5% without indexation.
• Debt Funds:
  • Short-Term Gains: Units sold within 3 years are added to your income and taxed as per your slab.
  • Long-Term Gains: Selling after 3 years, gains are taxed at 12.5%

Understanding how to calculate tax on mutual fund redemption for SIPs helps you plan better and save on taxes.

Tax on SWP Investments

A Systematic Withdrawal Plan (SWP) allows you to withdraw money from your mutual fund regularly. The tax on SWP investments depends on how long you’ve held the units:

• Equity Funds:
  • Short-Term Gains: Units held for 1 year or less are taxed at 20%.
  • Long-Term Gains: Units held for more than 1 year have gained over ₹1.25 lakh taxed at 12.5%.
• Debt Funds:
  • Short-Term Gains: Units held for 3 years or less are taxed according to your income slab.

Long-Term Gains: Units held for over 3 years are taxed at 12.5% if purchased before 1st April, 2023. If purchased after, tax applicable at investor’s personal income tax slab rate.

What taxes do NRI have to pay?

Tax Rate:

• Tax on Short-Term Capital Gains (STCG) from Debt (non-equity) mutual funds: Based on your income tax slab
• Tax on Long Term Capital Gains (LTCG) from Debt (non-equity) mutual funds:  12.5% if purchased before 1st April 2023 and based on slab rate if purchased after. 
• Tax on Short Term Capital Gains (STCG) from equity mutual funds: 20%
• Tax on Long Term Capital Gains (LTCG) from equity mutual funds:  12.5% on gains above ₹1.25 lakh in a financial year

Read NRI Taxation for Mutual Funds here.

TDS:

Unlike resident Indians, any withdrawals from mutual funds by NRIs are subject to a deduction of TDS. The money you receive in your bank account from withdrawals is net of the TDS amount. TDS is charged at the highest income tax slab rate. When you file your tax returns in India, you can get the excess TDS amount as a refund. The following TDS rates apply:

• TDS on Short Term Capital Gains from debt (non-equity) mutual funds: 30%
• TDS on Long Term Capital Gains from debt (non-equity) mutual funds:  20% with indexation benefit
• TDS on Short-Term Capital Gains from equity mutual funds: 15% + cess
• TDS on Long-Term Capital Gains from equity mutual funds:  10%

Securities Transaction Tax (STT)

When you buy or sell certain securities in India, you pay a small fee called the Securities Transaction Tax (STT). This tax applies to transactions of equity shares and equity-oriented mutual funds on the stock exchange.

• When Does STT Apply to Mutual Funds?
  • Equity Funds: STT is charged when you sell units of equity mutual funds.
  • Rate: As of 2024, the STT rate for selling equity mutual fund units is 0.001% of the transaction value.
• Why Is STT Important?
  • Added Cost: STT increases the cost of your transaction slightly.
  • Tax Calculation: You cannot deduct the STT paid from your taxable income or capital gains. This means it doesn’t reduce the tax you owe on mutual fund profits.
• Example:
  • If you sell equity mutual fund units worth ₹1,00,000, an STT of ₹10 (0.001% of ₹1,00,000) will be charged.

Points To Keep in Mind for Tax on Mutual Funds

1. Every withdrawal of units of mutual funds attracts capital gains irrespective of SIP, SWP, or SPT.
2. Capital gains are taxable in the financial year you redeem your units.
3. Make sure you select the correct income tax return applicable to you. 
4. If you are a salaried taxpayer with capital gains, ITR-2 is applicable. Read our article to learn which ITR to file.
5. You can set off the loss from capital assets with capital gains. You can set off a short-term capital loss with LTCG and STCG. However, you cannot set off long-term capital loss with STCG. Furthermore, you can only set off long-term capital loss with LTCG.
6. The period of holding is a significant factor. It is advisable to hold the investments for a more extended period. The longer you hold your investments, the more tax you will save. This is because the tax on long-term capital assets is lower than on short-term capital assets. 

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