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How are Mutual Fund Returns Taxed in India?

Taxes offered on mutual fund investment primarily depend on the type of fund, investment duration, and income tax slab an investor falls under.

Income from mutual funds is also included in taxable income. Dividends are taxed as per the applicable tax slabs, too.

Individuals willing to learn about mutual fund taxation and invest accordingly must read the following sections to make an informed investment decision.

How Investors Can Earn by Investing in Mutual Funds?

When investors invest money in mutual funds, they earn in three ways. These are as follows,

1. Income from Dividend or Bond Interest Gain

Investors can earn from dividends on shares of stocks and interest on bonds that are included in a portfolio. Investors can choose to receive dividends and earn from them, or they can reinvest their dividends and earnings to buy more shares.

2. Capital Gain from Selling Securities

Investors buy units of mutual funds at a particular price. If that price increases in the future, investors can choose to sell units and earn capital profit.

Note: Both the income from dividends and capital gains under the mutual fund are taxable.

3. Increase the Price of the Mutual Fund Scheme

When the prices of mutual funds increase, and the fund manager decides not to sell them, the prices automatically go up. Here, investors can sell units of mutual funds to make a profit.

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How Mutual Fund Returns are Taxed?

There are different types of mutual funds, namely, equity funds, debt funds, and hybrid funds. These funds are taxed in India differently. Let’s learn about Mutual Fund taxation in detail.

1. Taxation on Dividends Earned from Mutual Funds

Dividends that the investors get added in the calculation of total taxable income are taxed as per applicable slab rates. This amendment reduces the burden on small investors.

2. Taxation on Capital Gains Earned from Mutual Funds

Taxation rates of capital gains earned from mutual funds depend on mutual fund type (equity, debt, and hybrid) and holding period. The holding period refers to the time between the purchase date of units of a mutual fund and the selling date of the same.

3. Taxation on Capital Gains Earned from Equity Funds

Equity funds are mutual funds that primarily invest in equities (at least 65%). Investors can gain short-term capital gains (STCG) at a tax rate of 20% (irrespective of the income tax bracket they are all under) if they hold units of equity mutual funds for less than 1 year.

In case of a holding period of more than a year, the investor realizes long-term capital gains (LTCG). If investors sell units after 1 year and gain ₹1 lakh, these are tax-exempt. However, if the gains cross the threshold of ₹1 lakh, they attract a long-term capital gains tax of 12.5% without indexation on amounts exceeding ₹1 lakh.

4. Taxation on Capital Gains Earned from Debt Funds

Debt funds are mutual funds that invest in fixed-income securities like bonds, treasury bills, etc. Investors can gain short-term capital gains (STCG) tax if they redeem units of debt funds within 36 months. Here, the debt mutual fund taxation will occur according to the applicable income tax slab rates. Capital Gains from debt funds are included in the Total Taxable Income of the person.

On the other hand, if one sells units of debt funds after a holding period of 36 months, the taxation on long-term capital gains (LTCG) will occur at a rate of 20% with indexation. Debt fund taxation will further include cess and surcharge.

5. Taxation on Capital Gains Earned from Hybrid Funds

The taxation of hybrid funds or balanced funds occurs as per the equity exposure of a portfolio.

If a portfolio has an equity exposure of more than 65%, then the taxation follows similar rules to that equity mutual fund taxation policy.

On the other hand, in case the equity exposure is less than 65%, then the taxation follows similar rules of debt fund taxation policy. In addition, if a hybrid or balanced fund has 50% investment in equity and 50% investment in debt, the taxation rule will follow the debt fund taxation policy.

6. Taxation of Capital Gains Invested Through SIP

Systematic Investment Plans (SIPs) are investment methods where investors make small investments periodically (weekly, monthly, quarterly, bi-annually, or annually) in a mutual fund scheme.

In case investors sell units of a mutual fund invested through SIP after holding it for more than 1 year, investors can realize long-term capital gain (LTCG) on that purchased unit. Here, there is no SIP taxation if the gains do not exceed ₹1 lakh.

On the other hand, investors can start getting short-term capital gains (STCG) from the second month onward. Here, irrespective of income tax slab, investors have to pay 15% tax on these gains, including applicable cess and surcharge. The taxation rules differ in the case of investors investing in mutual funds through Systematic Investment Plans (SIPs).

Take a glance at the table mentioned below to understand the diverse types of mutual funds, their different holding periods, and applicable tax rates.

Fund Type	Short-term Capital Gains	Long-Term Capital Gains
Equity Funds	Shorter than 12 months 20% + cess + surcharge	12 months and longer Up to ₹1 lakh a year is tax-exempt. Any gains above ₹1 lakh are taxed at 12.5% + cess + surcharge.
Debt Funds	Shorter than 36 months Taxed at the investor’s income tax slab rate	36 months and longer 20% + cess + surcharge
Hybrid Equity-Oriented Funds	Shorter than 12 months 15% + cess + surcharge	12 months and longer Up to ₹1 lakh a year is tax-exempt. Any gains above ₹1 lakh are taxed at 10% + cess + surcharge.
Hybrid Debt-oriented Funds	Shorter than 36 months Taxed at the investor’s income tax slab rate	36 months and longer 20% + cess + surcharge

Mutual fund taxation is indeed a complex topic. However, after reading the sections mentioned, understanding the same is not an issue anymore. Now, investors can make an informed investment decision as per their investment goals and risk appetite.

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