Factors Affecting Mutual Funds Taxation

What's one popular investment avenue for achieving financial goals? It's none other than mutual funds. One of their main advantages is their tax efficiency. But investors who overlook the tax implications may not be making the most of their investments. Jump into this informative guide to explore details about tax on mutual funds.

Understanding How They are Taxed

So, is mutual fund income taxable? Like most asset classes, you will have to bear taxes on gains and profits from these assets. Plan your investments in a way that allows you to reduce your overall burden. Investors should also take advantage of tax deductions in applicable scenarios.

Factors Influencing Taxation for Mutual Funds

You should be aware of the major characteristics that have an impact on tax on mutual funds:

  • Type
    Two distinct categories of mutual funds have different taxation policies. Debt and equity funds are taxed differently from one another.
  • Capital Gains
    One of the major factors affecting mutual funds taxation is the profit you make by selling such assets.
  • Dividend
    The portion of profits directly distributed to the investors also has an influence over taxation. The distinction between capital gains and dividends generated is that the latter is available without having to sell the assets.
  • Holding Period
    The time for which you are investing in them is one of the significant factors affecting mutual funds taxation. Your burden will be significantly less if you have a long holding period.

How Do Mutual Funds Generate Profits?

Investing in mutual funds enables investors to earn dividend income or capital gains. Let's define them and look more closely at how they differ.

A capital gain is the profit made when an asset is sold for more than its original cost. However it's important to keep in mind that capital gains are only recognized when the mutual fund units are redeemed. Therefore, the only time the capital gains tax on mutual funds is owed is at redemption. Thus, when the income tax returns for the next fiscal year are filed, the tax on mutual fund redemption must be paid.

Dividends are another way that investors in mutual funds might get money from a fund. The Mutual Fund declares dividends in accordance with its cumulative distributable surplus.

Dividends are disbursed at the fund's discretion to investors and are immediately taxable. As a result, investors are required to pay tax on any dividends they get from their mutual funds.

Dividend Income Taxation

Up until March 31, 2020, investors were not required to pay taxes on dividends generated from mutual funds. Before distributing these profits to investors, the fund houses used to deduct Dividend Distribution Tax. But the Finance Act of 2020 eliminated the requirement for DDT.

Now, investors must report these profits on their ITR and pay taxes on it based on their bracket. Mutual fund dividends are also subject to TDS. If the total payable in a financial year exceeds Rs 5,000, the AMC must deduct 10%. When filing tax on mutual funds, investors can claim the deducted amount and pay taxes on the remaining.

Capital Gains Taxation

The income tax on mutual funds capital gains will depend on the holding period. This refers to the time between the purchase and sale of the units. The categories applicable to capital gains on the sale of assets are as follows:


Fund Type

Short-Term Holding Period

Long-Term Holding Period

Equity funds

Lower than 12 months

Higher than 12 months

Debt funds

Lower than 36 months

Higher than 36 months

Equity-Oriented Hybrid Fund

Lower than 12 months

Higher than 12 months

Debt-Oriented Hybrid Fund

Lower than 36 months

Higher than 36 months




Tax on Equity Fund Capital Gains

These are schemes primarily investing over 65% of their capital in equity shares of companies. Short-term capital gains, realized within a year of redeeming units, are subject to a flat 15%, regardless of the income bracket.

Long-term capital gains, earned by holding equity fund units for more than a year, are tax-exempt up to Rs 1 lakh per year. Any long-term capital gains exceeding Rs 1 lakh annually are subject to 10% without the benefit of indexation.

Tax on Debt Fund Capital Gains

Funds with at least 65% debt and less than 35% equity exposure started experiencing changes in their taxation from April 1, 2023. Previously, long-term capital gains from these assets were subject to a 20% tax with the benefit of indexation. However, the advantage of adjusting costs according to inflation is no longer available.

It means that the gains from debt funds will be added to your taxable income, and you will have to pay according to your applicable bracket. This change in taxation could significantly impact investors who rely on these assets for their returns. It is important to consult with a financial advisor to understand how the changes may affect your investment strategy.

Tax on Hybrid Fund Capital Gains

The amount of capital gains tax on mutual funds paid on balanced or hybrid funds depends on how much of the portfolio is invested in equities. If equity exposure is over 65%, then the fund is taxed like an equity fund. In other circumstances, it is taxed like a debt fund. It's important to know the exposure of your hybrid fund, or you risk being surprised by taxes when you redeem your units.

Here's a table summarizing capital gains tax rates for mutual funds:


Short-Term Capital Gains

Long-Term Capital Gains

Equity funds

Hybrid equity-oriented funds

15% + cess + surcharge

Any profit higher than Rs 1 lakh is taxed at 10% + cess + surcharge

Debt funds

Hybrid debt-oriented funds

Tax bracket of the investor

Tax bracket of the investor



Securities Transaction Tax

In addition to the tax on dividends and capital gains, there is another one called the Securities Transaction Tax (STT). When you purchase or sell an equity or a hybrid equity-oriented fund unit, the government levies an STT of 0.001%. But there is no STT when you sell debt fund units.

Capital Gain Tax for SIP

Systematic Investment Plans allow you to invest a predetermined amount of money at regular intervals according to your preference. Each installment in an SIP results in the purchase of a certain number of mutual fund units. When redeeming these units, the first-in-first-out (FIFO) principle is followed, meaning the units purchased first are redeemed first.

Consider investing in an equity fund for one year and redeeming it after 13 months. You will get both long-term and short-term capital gains. Long-term capital gains on units are tax-free if they are less than Rs. 1 lakh. A flat 15% is applicable on short-term gains, regardless of your income tax slab. You will also need to pay the applicable cess and surcharge on your capital gains.


Investing in ELSS funds allows individuals to lower their taxation burden while simultaneously growing their corpus. The payable tax on mutual funds remains consistent regardless of whether they are acquired as a lump sum or via SIP. Nevertheless, holding the fund units for a longer tenure can provide better advantages compared to short-term holdings.

Frequently Asked Questions Expand All

When you invest in such schemes, you will be taxed only upon the sale or redemption of units. Annual taxation is not applicable. But dividends earned from mutual funds are included in your total annual income. If your overall earnings fall under the taxable bracket, you must pay taxes on the dividend income.

Benefits are available under Section 80C for investments made in ELSS. Investors are entitled to claim up to Rs.1.5 lakh in tax deductions and potentially save up to Rs.46,800 annually. But these investments
carry a mandatory lock-in period of three years before withdrawals are allowed.


Paying tax on profits after selling the asset is unavoidable. But tax-efficient investment planning can minimize liabilities. Remember that short-term capital gains have higher tax rates than long-term ones. So, plan your investments accordingly. 


ELSS are tax-saving assets under Section 80C. You can enjoy several deductions while investing in these funds.