Tax on Mutual Funds in India – A Complete Guide

The July 2024 Union Budget changed several important capital gains rules that affect mutual fund investors in India. If you invest in equity funds, debt funds, hybrid funds, gold funds, international funds, ETFs, or fund of funds, the tax treatment may now be different from what it was earlier.

This guide covers the updated rules in a practical way: STCG, LTCG, dividend taxation, SIP and SWP taxation, fund switching, loss set-off, ELSS, and NRI taxation. The goal is simple: help you understand how mutual fund taxation works now, and where investors usually get confused.

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What Changed in July 2024? (Summary)

The Finance (No. 2) Act, 2024, effective for transfers made on or after 23 July 2024, changed important capital gains rules relevant to mutual fund investors. Budget 2025 and Budget 2026 did not change these rates further.

• Equity-oriented fund STCG rate increased from 15% to 20%
• Equity-oriented fund LTCG rate increased from 10% to 12.5%, while the annual exemption increased from Rs 1 lakh to Rs 1.25 lakh
• Indexation benefit was removed in cases where the new 12.5% LTCG regime applies
• Holding periods were simplified broadly into two buckets: 12 months for listed securities and 24 months for other capital assets
• Specified mutual fund rules under Section 50AA continue to matter for debt-oriented categories, especially for units acquired on or after 1 April 2023
• Section 50AA definition narrowed from FY 2025-26 (AY 2026-27): Under the Finance (No. 2) Act 2024, the definition of "specified mutual fund" was amended. From FY 2025-26 onwards, only funds that invest more than 65% of their total proceeds in debt and money market instruments (or FoFs investing 65% or more in such funds) fall within Section 50AA. Gold ETFs, international funds, and gold FoFs that were previously caught by the old "not more than 35% in domestic equity" threshold are now outside Section 50AA and follow normal listed or unlisted non-equity rules instead.

This means the tax result depends not only on fund category, but also on the date of purchase, date of sale, and in some cases, whether the unit is listed or unlisted.

Translating these rules into a tax-efficient redemption and holding strategy for your specific portfolio is where planning makes a difference. Finnovate's tax planning advisory covers mutual fund capital gains, loss harvesting, and annual ITR alignment: tax planning advisory at Finnovate

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Mutual Fund Taxation: Before vs. After 23 July 2024

Notes:
Tax rates above are exclusive of surcharge and 4% Health & Education Cess.
The listed vs unlisted distinction matters for several non-equity mutual fund categories after 23 July 2024.
Debt-oriented schemes covered by Section 50AA need separate treatment from other non-equity mutual funds.

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Equity Mutual Funds (Generally at Least 65% in Domestic Equities)

Which funds usually qualify as equity-oriented?

A mutual fund is generally treated as equity-oriented for tax purposes if at least 65% of its assets are invested in domestic equity shares. This usually includes:

• Large-cap, mid-cap, small-cap, flexi-cap, focused, and value funds
• Thematic and sector funds
• ELSS funds
• Aggressive hybrid funds where domestic equity allocation is at or above the required threshold
• Arbitrage funds, which are treated as equity-oriented for tax purposes

Tax Rules (for transfers on or after 23 July 2024)

• Short-Term Capital Gains (STCG): Holding period up to 12 months, taxed at 20% under Section 111A, plus applicable surcharge and cess
• Long-Term Capital Gains (LTCG): Holding period above 12 months, taxed at 12.5% under Section 112A, plus applicable surcharge and cess
• Annual exemption: The first Rs 1.25 lakh of eligible long-term capital gains across equity shares and equity-oriented funds in a financial year is exempt

ELSS (Equity Linked Savings Scheme)

ELSS funds are equity-oriented mutual funds with a mandatory 3-year lock-in. They are the only mutual fund category that gives a deduction at the time of investment under Section 80C, up to Rs 1.5 lakh, and that deduction is available only under the Old Tax Regime.

On redemption after the lock-in period, gains are treated as LTCG and taxed under the same equity-oriented fund rules. Since early redemption is not allowed, STCG does not arise in a normal ELSS redemption.

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Debt Mutual Funds Taxation

Debt funds include liquid funds, ultra short duration funds, money market funds, corporate bond funds, gilt funds, banking and PSU debt funds, and similar schemes. For tax purposes, the purchase date remains very important.

Scenario A: Units acquired on or after 1 April 2023 and covered by Section 50AA

Where a debt-oriented mutual fund falls within the definition of a specified mutual fund under Section 50AA, gains on transfer or redemption of units acquired on or after 1 April 2023 are treated as short-term capital gains, irrespective of how long you hold them.

That means:

• No LTCG benefit
• No indexation
• Tax at your applicable slab rate

Scenario B: Units acquired on or before 31 March 2023

For debt fund units purchased before 1 April 2023, the pre-Section 50AA treatment may apply depending on the scheme. If such units are transferred on or after 23 July 2024, the long-term tax rate is 12.5% without indexation where LTCG treatment applies under the amended regime.

Older units may still be treated more favourably than new debt fund purchases, but the result depends on the exact category, the transfer date, and the applicable transition rule.

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Hybrid Mutual Funds Taxation

Hybrid funds sit between equity and debt. Their tax treatment depends mainly on how much domestic equity they hold and whether the unit is effectively taxed as equity-oriented, specified debt-oriented, or other non-equity.

Three broad buckets

• Aggressive hybrid funds with sufficient domestic equity exposure may be taxed like equity-oriented funds
• Debt-heavy hybrid funds may be covered by Section 50AA if they invest more than 65% in debt and money market instruments
• Middle-bucket hybrid funds that are not equity-oriented and not covered by Section 50AA may fall under the non-equity listed or unlisted rule

Practical rule for many non-equity hybrid funds

Where the fund is not taxed as equity-oriented and is not covered by Section 50AA, LTCG treatment after 23 July 2024 depends on whether the units are listed or unlisted:

• Listed units: Long-term if held for more than 12 months
• Unlisted units: Long-term if held for more than 24 months
• LTCG rate: 12.5% without indexation
• STCG: Taxed as per applicable normal rate rules

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Gold Funds, International Funds & Fund of Funds Taxation

This is one of the most misunderstood areas because investors often group all these products together. The classification also changed materially from FY 2025-26.

The Section 50AA definition change from FY 2025-26

Under the Finance (No. 2) Act 2024, the definition of "specified mutual fund" under Section 50AA was narrowed, effective from FY 2025-26 (AY 2026-27). Under the old definition, any fund with not more than 35% in domestic equity qualified as a specified mutual fund and was caught by Section 50AA. Under the revised definition, only funds that invest more than 65% of their total proceeds in debt and money market instruments (or FoFs investing 65% or more in such funds) are covered.

The practical effect: Gold ETFs, gold FoFs, and most international funds, which had been caught by the old 35% equity threshold in FY 2024-25, are generally outside Section 50AA from FY 2025-26 and follow normal listed or unlisted non-equity capital gains rules instead.

How gold and international funds are generally taxed from FY 2025-26

• Listed non-equity units (such as Gold ETFs): long-term if held for more than 12 months, LTCG at 12.5% without indexation
• Unlisted non-equity units (such as many Gold FoF and international FoF structures): long-term if held for more than 24 months, LTCG at 12.5% without indexation
• If a fund is still covered by Section 50AA (because it meets the revised 65% debt threshold): gains continue as short-term capital gains at slab rate regardless of holding period

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Which Mutual Fund Categories Are Most Tax-Efficient?

Tax efficiency in mutual funds depends on your holding period, tax bracket, and fund structure. The ranking below is by category for a long-term investor in a higher tax bracket. It does not constitute a recommendation to invest in any specific scheme.

Note: Tax efficiency is one input into an investment decision, not the only one. Risk, return expectations, and investment goals matter equally. Please consult a SEBI-registered investment adviser before making investment decisions based on tax considerations alone.

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SIP and SWP Taxation

SIP taxation: what most investors get wrong

When you invest through SIP, each instalment is treated as a separate purchase with its own cost and its own holding period. Redemption follows the FIFO method: the earliest units purchased are treated as sold first.

SWP taxation: each withdrawal is a partial redemption

A Systematic Withdrawal Plan (SWP) operates as a series of partial redemptions. Each SWP instalment is a separate redemption event, and capital gains tax applies only on the gains portion of each withdrawal, not the entire withdrawal amount.

The same FIFO and holding period rules that apply to SIP redemptions apply to SWP withdrawals. Older units are considered sold first. If the units being redeemed were purchased more than 12 months ago (for equity-oriented funds), those gains qualify as LTCG. If within 12 months, STCG applies.

For resident investors, there is generally no TDS on capital gains arising from SWP withdrawals. Tax is self-assessed and reported in the ITR.

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Taxation on Switching Mutual Funds

A switch from one mutual fund scheme, plan, or option to another is generally treated as a redemption plus fresh purchase for tax purposes.

This means:

• The switch can trigger a capital gain or capital loss on the date of switch
• The gain may be STCG or LTCG depending on the holding period of the original units
• The new investment starts a fresh holding period from the switch date
• This can apply even when you move between Regular and Direct plans or between Growth and IDCW options

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Dividend / IDCW Taxation on Mutual Funds

What many investors still call "dividend option" is now commonly referred to as IDCW (Income Distribution cum Capital Withdrawal). When a mutual fund pays IDCW, the NAV drops by the amount distributed. It is not extra return added over and above the fund value.

Example: If the NAV is Rs 22 and the scheme distributes Rs 3 as IDCW, the NAV adjusts to around Rs 19, subject to usual valuation movements.

How IDCW is taxed

• Tax in your hands: IDCW is added to your income and taxed at your applicable slab rate
• Resident TDS: AMC deducts 10% TDS if total IDCW paid or credited by that AMC to you exceeds Rs 5,000 in a financial year
• Capital gains: For resident investors, there is generally no TDS on mutual fund capital gains. TDS on capital gains applies mainly to NRI investors

Growth vs IDCW

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Capital Loss Set-Off & Carry Forward

Capital losses from mutual funds can be used to reduce tax liability, subject to the normal set-off rules.

Rules for setting off losses

• Short-Term Capital Loss (STCL): Can be set off against both STCG and LTCG
• Long-Term Capital Loss (LTCL): Can be set off only against LTCG

Carry forward of losses

• Unused capital losses can be carried forward for up to 8 assessment years
• Filing the income tax return within the due date is required to preserve this carry-forward benefit

Tax-loss harvesting

If some holdings are in loss, booking those losses before the financial year ends can help offset gains elsewhere. The strategy should be executed carefully and in line with the overall investment plan, not only for tax reasons.

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NRI Mutual Fund Taxation in India

NRIs can invest in Indian mutual funds, but the tax experience differs mainly because TDS is generally deducted at source on redemption gains. Resident investors do not face TDS on capital gains from mutual fund redemptions.

TDS rates for NRI investors (from 23 July 2024)

• Equity-oriented fund STCG: TDS at 20% plus applicable surcharge and cess
• Equity-oriented fund LTCG: TDS at 12.5% plus applicable surcharge and cess
• Debt and other non-equity fund gains: TDS depends on the nature of the gain. Where Section 50AA applies and the gain is treated as STCG, TDS is at applicable slab rates (typically 30% plus surcharge and cess for NRIs without DTAA benefit). Where the gain qualifies as LTCG on non-equity units outside Section 50AA (such as a Gold ETF held over 12 months), TDS is at 12.5% plus applicable surcharge and cess. Actual TDS may vary based on the applicable section, DTAA eligibility, and documentation submitted.
• IDCW: TDS at 20% or at the applicable DTAA rate, whichever is lower, subject to submission of valid documentation

DTAA relief may reduce the TDS rate where the investor's country of residence has a tax treaty with India. To claim DTAA relief, the NRI investor generally needs to submit a valid Tax Residency Certificate (TRC) and Form 10F to the AMC before redemption. If TDS is over-collected, the NRI can file an Indian ITR to claim a refund.

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Ready to see how taxation impacts your portfolio?

• Book a consultation with a Finnovate expert to review the tax side of your mutual fund portfolio.
• Learn about our tax planning advisory

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Key Takeaways

Mutual fund taxation in India is no longer something you can judge only by hearing "equity" or "debt." The actual answer often depends on fund structure, purchase date, sale date, and in some cases whether the units are listed or unlisted.

• Equity-oriented funds: STCG is 20% (up from 15% on 23 July 2024) and LTCG is 12.5% above the Rs 1.25 lakh annual exemption
• Debt-oriented specified mutual funds: Units acquired on or after 1 April 2023 continue to be taxed as short-term capital gains regardless of holding period
• Section 50AA definition narrowed from FY 2025-26: Only debt-oriented funds (more than 65% in debt instruments) remain covered. Gold ETFs, international funds, and most gold FoFs are now outside Section 50AA
• Non-equity funds not covered by Section 50AA: Long-term treatment depends on whether units are listed (12 months) or unlisted (24 months)
• SIP and SWP investors: Each instalment and each withdrawal is assessed separately; FIFO applies on redemption
• IDCW investors: IDCW is taxed at slab rate; for higher-bracket investors, comparing Growth plus SWP against IDCW on an after-tax basis is worth doing
• NRI investors: TDS applies on capital gains at source. Rates are 20% for equity STCG, 12.5% for equity LTCG, 12.5% for eligible LTCG on non-equity units outside Section 50AA, and slab rates for Section 50AA gains. DTAA documentation should be submitted to the AMC before redemption.
• All investors: Filing ITR on time is necessary to carry forward capital losses

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FAQs

1. What is the LTCG tax rate on equity mutual funds in FY 2025-26?

LTCG on equity-oriented mutual funds held for more than 12 months is taxed at 12.5%, plus applicable surcharge and cess. The first Rs 1.25 lakh of eligible long-term capital gains in a financial year is exempt. This rate applies for transfers on or after 23 July 2024, increased from the earlier 10% above Rs 1 lakh.

2. What was the STCG rate on equity mutual funds before Budget 2024, and has it changed?

Yes. STCG on equity-oriented mutual funds was 15% for transfers up to 22 July 2024. It increased to 20% for transfers on or after 23 July 2024. The 20% rate applies to gains from equity-oriented fund units sold within 12 months of purchase.

3. How are SIP investments taxed when I redeem?

Each SIP instalment is treated as a separate purchase. FIFO applies on redemption. So one redemption can contain both long-term and short-term gains depending on the age of each instalment. The holding period is checked per instalment, not on the total SIP account as one block.

4. How is an SWP taxed?

Each SWP withdrawal is a partial redemption. Tax applies only on the capital gains component of each withdrawal, not the full amount withdrawn. FIFO applies: older units are considered sold first. If those units were held for more than 12 months (for equity funds), the gains qualify as LTCG at 12.5%. For resident investors, there is generally no TDS on SWP withdrawals. Tax is reported in the ITR.

5. Is switching between mutual funds a taxable event?

Yes, generally a switch is treated as a redemption followed by a fresh purchase. Tax is triggered on the original units on the date of switch, whether the switch is between schemes, between plans (Regular to Direct), or between options (Growth to IDCW).

6. Are debt mutual funds still tax-efficient after the July 2024 changes?

That depends mainly on purchase date and whether the scheme falls within Section 50AA. Many debt-oriented schemes acquired on or after 1 April 2023 continue to lose LTCG benefit and are taxed as short-term capital gains at slab rate, making them similar in tax outcome to a bank fixed deposit for the same holding period.

7. What is the tax on IDCW or dividends from mutual funds?

IDCW is added to your income and taxed at your applicable slab rate. Resident TDS at 10% applies if total IDCW from the same AMC exceeds Rs 5,000 in a financial year.

8. Can I save tax by investing in ELSS mutual funds?

Yes, under the Old Tax Regime. ELSS qualifies for deduction under Section 80C up to Rs 1.5 lakh, subject to the overall Section 80C limit. On redemption after the 3-year lock-in, gains are taxed under the equity LTCG rules at 12.5% above the Rs 1.25 lakh annual exemption.

9. How are capital losses from mutual funds treated?

STCL can be set off against both STCG and LTCG. LTCL can be set off only against LTCG. Unused losses can be carried forward for up to 8 assessment years, but only if the income tax return is filed within the due date.

10. Is TDS deducted on mutual fund redemptions for resident Indians?

Generally no. Resident investors do not face TDS on capital gains from mutual fund redemptions. TDS applies on IDCW once the Rs 5,000 per AMC threshold is crossed. NRI investors face TDS on capital gains at source: equity STCG at 20%, equity LTCG at 12.5%. For non-equity funds, the rate depends on the nature of the gain. Section 50AA gains are taxed as STCG at applicable slab rates; eligible LTCG on non-equity units outside Section 50AA is taxed at 12.5%. Surcharge and cess apply in all cases. DTAA documentation may reduce the applicable rate.

11. Does taking a loan against mutual fund units trigger capital gains tax?

No. Pledging mutual fund units as collateral for a loan is not a transfer under the Income Tax Act, so it does not trigger a capital gains tax event. Tax arises only on actual redemption or sale of units. If the lender sells the pledged units due to a loan default, that would constitute a transfer and capital gains tax would apply on the resulting gains.

12. How are gold and international mutual funds taxed now?

From FY 2025-26, Gold ETFs and most international funds are outside Section 50AA under the revised definition. A listed Gold ETF qualifies for LTCG at 12.5% after more than 12 months. An unlisted Gold FoF or international FoF requires more than 24 months for LTCG treatment. The Rs 1.25 lakh annual LTCG exemption does not apply to these funds as it is restricted to equity-oriented assets.

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Disclaimer: This article is for educational and informational purposes only and should not be treated as tax, legal, investment, or policy advice. Mutual fund taxation depends on the exact scheme structure, acquisition date, sale date, listed or unlisted status, and investor category. Tax rules are subject to change. Please consult a qualified CA or SEBI-registered investment adviser for advice specific to your situation.