With government support and advertisements like MutualFundsSahihai, mutual funds have become a popular choice among Indian investors seeking diversification and professional management. However, understanding the taxation aspects is crucial to maximize returns and ensure compliance with tax regulations. So what are the taxes in store as of March 2025?
Let us understand.
Understanding Mutual Fund Taxation
The taxation in India primarily depends on two factors: the type of fund (equity or debt) and the holding period of the investment.
1. Equity-Oriented Mutual Funds
These funds invest at least 65% of their assets in equity shares of domestic companies.
- Short-Term Capital Gains (STCG): If you redeem your equity fund units within 12 months of investment, the gains are considered short-term. As per the latest update in Budget 2024, STCG on equity funds is taxed at 20%.
- Long-Term Capital Gains (LTCG): Gains from units held for more than 12 months are classified as long-term. Effective from July 23, 2024, LTCG exceeding ₹1.25 lakh in a financial year are taxed at 12.5%.
2. Debt-Oriented Mutual Funds
These funds allocate a significant portion of their assets to debt securities like bonds and money market instruments.
- Short-Term Capital Gains (STCG): For holdings up to 24 months, gains are added to your income and taxed as per your applicable income tax slab rate.
- Long-Term Capital Gains (LTCG): Gains from units held for more than 24 months are taxed at 20% with indexation benefits.
Recent Changes in Taxation Policies
The Finance (No. 2) Act 2024 introduced significant amendments affecting investors:
- Definition of Specified Mutual Funds: Effective from FY 2025-26, a “specified MF” is defined as a fund investing more than 65% of its total proceeds in debt and money market instruments. This redefinition impacts the tax treatment of such funds. Source
- Withholding Tax for Resident Investors: Any mutual fund income or capital gains (short-term or long-term) received by a resident investor is subject to a 10% withholding tax rate. This means the tax authorities will deduct 10% at source before the investor receives the proceeds. Source
There has been a recent amendment to make section 80C to Section 123, more about it here.
Illustrative Examples
Let’s consider a couple of scenarios to understand the tax implications better:
Example 1: Equity Mutual Fund Investment
- Investment Amount: ₹2,00,000
- Holding Period: 18 months
- Redemption Amount: ₹2,80,000
- Capital Gain: ₹80,000
Since the holding period exceeds 12 months, the gain qualifies as LTCG. The taxable amount is ₹80,000, which is below the ₹1.25 lakh exemption limit. Therefore, no tax is payable.
Example 2: Debt Mutual Fund Investment
- Investment Amount: ₹5,00,000
- Holding Period: 30 months
- Redemption Amount: ₹6,00,000
- Capital Gain: ₹1,00,000
Here, the holding period exceeds 24 months, qualifying the gain as LTCG. After applying indexation, assume the indexed cost is ₹5,50,000. The taxable gain is ₹50,000, taxed at 20%, resulting in a tax liability of ₹10,000.
Taxation of Dividends
Dividends received from mutual funds are added to the investor’s income and taxed as per the applicable income tax slab rates. This applies to both equity and debt funds.
Tax-Saving Funds
Equity-Linked Savings Schemes (ELSS) are funds that offer tax benefits under Section 80C of the Income Tax Act, 1961. (It has been modified to Section 123 in the recent Income Tax Bill. Investments in ELSS up to ₹1,50,000 per annum are eligible for tax deduction, with a mandatory lock-in period of 3 years.
You can read more about ELSS and its tax saving here.
Understanding the taxation aspects of mutual fund investments is essential for effective financial planning. Keeping abreast of the latest tax regulations ensures compliance and helps in optimizing returns. Always consider consulting a tax advisor to align your investment strategy with your tax obligations.
FAQs
1. Do I have to pay tax on mutual funds even if I don’t redeem them?
No, mutual funds are only taxed when you sell or redeem your units. As long as you hold the investment, there is no tax liability. However, if you invest in a dividend-paying mutual fund, the dividends are taxable as per your income tax slab, even if you don’t redeem your units.
2. What happens if I switch from one mutual fund to another?
Switching from one scheme to another is considered a redemption and is taxable. If you move funds between equity funds, LTCG or STCG tax applies based on the holding period. The same rule applies to switching between debt funds.
3. How is taxation different for index funds compared to actively managed mutual funds?
The tax treatment for index funds and actively managed mutual funds is the same. For equity index funds, STCG is taxed at 20%, while LTCG above ₹1.25 lakh is taxed at 12.5%. Debt index funds follow debt taxation rules, where LTCG is taxed at 20% with indexation benefits if held for more than 24 months.
4. How do I calculate tax on mutual funds if I invested through SIPs?
Each SIP installment is treated as a separate investment with its own holding period. When you redeem, the tax is calculated based on a FIFO (First In, First Out) basis. This means older SIP units are sold first, and the holding period determines whether STCG or LTCG applies.
5. Can I offset my mutual fund losses against other capital gains?
Yes, capital losses from mutual funds can be adjusted:
- Short-term capital losses (STCL) can offset both STCG and LTCG.
- Long-term capital losses (LTCL) can only be adjusted against LTCG, not STCG.
- Unused capital losses can be carried forward for up to 8 years.
6. Are flexi-cap funds taxed differently from multi-cap or large-cap funds?
No, flexi-cap funds follow the same tax rules as other equity mutual funds. Since they maintain at least 65% equity exposure, they are taxed under equity taxation rules—20% STCG and 12.5% LTCG above ₹1.25 lakh.
7. What tax benefits do ELSS funds offer, and how are withdrawals taxed?
Equity-Linked Savings Scheme (ELSS) funds qualify for Section 80C tax deduction up to ₹1.5 lakh per year, reducing taxable income. However, after the 3-year lock-in period, any gains above ₹1.25 lakh are taxed at 12.5% LTCG.
8. Is TDS applicable on mutual fund redemptions?
For resident investors, there is no TDS on such redemptions. However, for NRIs, a 10% TDS on LTCG and 15% on STCG applies for equity funds. For debt funds, 30% TDS on STCG and 20% TDS with indexation on LTCG applies.
9. How does mutual fund taxation compare with fixed deposit (FD) taxation?
- Mutual fund taxation depends on capital gains and the holding period.
- Fixed deposits (FDs) are taxed based on interest earned, which is added to your income and taxed as per your slab rate.
- Mutual funds offer the benefit of indexation for long-term debt investments, which FDs do not.
10. How do I report mutual fund gains in my ITR (Income Tax Return)?
You must report capital gains in Schedule CG of your ITR-2 or ITR-3. LTCG and STCG must be separately disclosed for equity and debt funds. If your gains exceed ₹1 lakh, ensure they are correctly reported to avoid notices from the Income Tax Department.
