Calculating Capital Gains Tax On Mutual Funds: What You Need To Know

• Short-term capital gains (STCG) on equity mutual funds (held for less than 12 months) are taxed at 15%

• For debt mutual funds (held for less than 36 months), STCG is taxed as per the investor’s income tax slab

• Long-term capital gains (LTCG) on equity mutual funds (held for more than 12 months) are taxed at 10% if gains exceed ₹1 lakh

• Debt fund LTCG (held for more than 36 months) is taxed at 20% with indexation benefits (if applicable)

Mutual funds are a pool of investments used for buying shares, securities, debt instruments, etc., from the market. Understanding capital gains tax on mutual funds is crucial for investors seeking a comprehensive grasp of their financial outcomes. 

The profits earned from investments in mutual funds are known as capital gains, which are subject to tax. It is important to understand how your gains will be taxed before investing in mutual funds.

Profits from selling mutual fund units within a given holding period, which varies depending on the type of mutual fund, are subject to the capital gains tax. 

The holding period for short term capital gain on mutual fund, especially equity-oriented funds, is less than a year. The tax rate is flat at 15% regardless of your income tax slab, plus any relevant surcharge and cess. Funds that invest at least 65% in stock and associated products are subject to this requirement. 

The tax rate for debt-oriented mutual funds is determined by your income tax bracket and the STCG holding period for such funds is less than 36 months. Significant adjustments to the taxation of units of particular mutual funds were implemented in Budget 2024. 

The new proposal taxes gains on specified mutual funds as short-term capital gains irrespective of the holding period, applicable to units acquired after April 1, 2023.

LTCG on mutual funds is applicable when you sell a capital asset after holding it for more than 12 months. If your LTCG exceeds ₹1 lakh, such gains are taxable. 

After the introduction of Section 112A, the tax rate for LTCG on mutual funds is 10% without any indexation benefit. However, income tax on long term capital gain on mutual funds is only applicable in the year when it is sold or redeemed.

Mutual funds are subject to specific tax regulations based on various factors:

• Fund Types: Taxation rules vary depending on the type of mutual fund. Each type has distinct tax implications due to differences in investment strategies and asset allocations.

• Dividend: A dividend is a portion of the profit distributed to investors by mutual fund houses. Equity funds typically offer dividends as a reward to long-term investors, while debt funds may also distribute dividends, which are taxed differently based on holding periods and other factors.

• Capital Gains: Capital gains occur when investors sell their mutual fund units at a profit. 

• Holding Period: The time duration between the purchase and sale of mutual fund units plays a significant role in taxation. A longer holding period generally results in lower tax liabilities.

Whether you're dealing with equity or debt funds, knowing how tax on mutual fund returns is calculated can help you optimise returns and plan your finances effectively.

Equity funds invest in equity shares of different companies. Tax-saving equity funds, known as Equity Linked Savings Scheme (ELSS), have a lock-in period of 3 years, resulting in long-term capital gains taxed at 10% if the gains exceed ₹1 lakh.

These mutual funds invest in both equity shares and debt. For equity-oriented hybrid funds, 65% of the funds should be invested in equity shares and the remaining 35% in debt instruments. The capital gains on these funds are similar to that of equity funds.

Debt funds purchase debt instruments from the market. LTCG on mutual funds investing in debt instruments are taxed at 20% after considering the benefit of indexation. The indexation is done based on the cost inflation rate, which can reduce the capital gain chargeable to tax. 

No indexation benefit is available for calculating LTCG on debt mutual funds investing less than 35% of their corpus in equities or equity-related instruments. LTCG on such debt funds will now be taxed according to the investor’s applicable slab rates, applicable for investments made after April 1st, 2023.

These mutual funds invest in both equity and debt instruments with 60% of the amount invested in debt instruments and 40% in equity shares. 

A 20% tax rate is applicable on the capital gains from selling debt-oriented balanced funds, calculated after considering the benefit of indexation.

LTCG from the sale of unlisted equity funds attract tax at 20% after the benefit of indexation, including cess tax and surcharge. For unlisted equity shares, you have the option to take indexation benefits or not, calculating your tax liability both with indexation at 20% and without indexation at 10% and choosing whichever is more beneficial.

Changes in tax rates and exemption limits were introduced in Budget 2024, affecting both short-term and long-term capital gains. Here’s a summary of the tax rate applicable to different types of mutual funds.

In the case of SIPs, each installment is considered a separate investment and taxed separately. The tax rate depends on the type of funds in which it was invested.

There are also some capital gain exemptions on mutual funds as follows:

Mutual fund capital gains are excluded from taxation under Section 10(38) of the Income Tax Act if the transfer occurred after October 1st, 2004, if a long-term asset was transferred or if a selling transaction results in Securities Transaction Tax (STT). 

If you purchase an asset a year prior to or two years following the date of sale or if you build a property using your capital gains from sales within three years of the date of sale, you may be eligible for tax benefits on the sale of an asset under Section 54F.

Understanding the capital gains tax on mutual funds can now help you in evaluating mutual funds with an added perspective towards profitability and tax.

The tax applied to capital gains resulting from mutual fund redemption is determined by the type of mutual fund and the duration for which it was held.

Short-term capital gain (STCG) is the profit realised from the sale of assets held for one year or less and is taxed as ordinary income. Long-term capital gain (LTCG) is the profit realised from the sale of assets held for more than one year and is taxed at a lower rate.

Short-term capital gains from equity mutual funds (held for up to 12 months) are now subject to a 20% tax rate. Conversely, long-term capital gains (held for more than 12 months) are taxed at a uniform rate of 12.5%.

Yes, long-term capital gains are realised upon the sale of equity fund units held for over one year. These capital gains are tax-exempt up to ₹1 lakh annually. Any long-term capital gains exceeding this limit are subject to LTCG tax at 10% without indexation benefit.

Income received as dividends from mutual funds (now referred to as IDCW) will be taxed as 'Income from Other Sources' in accordance with your applicable income tax slab rate. In cases where the dividend amount exceeds ₹5,000, the dividend will be subject to TDS as per Section 194K at a rate of 10% for resident individuals. However, if a PAN is not provided, the TDS rate will be 20%.

The tax rate for LTCG on mutual funds is 12.5%.

Yes, capital gains are tax-free, up to ₹1.25 lakh per year.

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