Mutual fund taxation - How are MF returns taxed?

What is Tax on Mutual Funds?

Understanding mutual fund taxation is crucial for every investor in India. The tax on mutual fund investments varies depending on several factors, such as the type of scheme (equity or debt), duration of holding, and the mode of investment. Broadly, investors should be aware that both capital gains and dividends may be taxed. Being informed about mutual fund taxation ensures you plan your finances and optimise post-tax returns.

Mutual fund taxation

The first thing you should know is that, when you invest in mutual funds, you receive returns in two ways – dividends and capital gains. While dividends are the pay-outs emerging from a company’s profit or surplus cash, capital gains are acquired when you sell off the units you hold in the scheme. Both dividends and capital gains are based on the number of mutual fund units you hold. Both of these returns are taxable when you receive them. Now, let us look at the tax on dividends – the dividends you receive from your fund units are added to your taxable income, and then taxed in line with your income tax slab. 

Separately, the capital gains you earn are taxed based on the time frame of your holding, as well as the type of mutual fund you invest in. so, if you invest in equity funds for less than a year, you will be taxed at 15%, and if the investment is more than a year, it will be taxed at 10%, after the initial 1 lakh, which is tax exempt. Equity funds are mutual fund schemes which invest 65% or more of the corpus in equity and equity-related instruments. When it comes to debt funds, which are schemes investing 65% or more of the corpus in debt instruments, then you attract short term capital gains tax, in line with your income tax slab, if you redeem your units within three years. After this duration, your returns are taxed at 20%, irrespective of your tax slab. You also receive an indexation benefit on your redemption, which means that your capital gains can be adjusted to the inflation in the period of investment.   

What Are the Factors to Determine Tax on Mutual Funds?

Several elements influence tax on mutual fund investments in India. The type of mutual fund, whether equity or debt, significantly affects tax treatment. The holding period—short or long term—also determines the rate at which capital gains are taxed. Additionally, whether the investment is made through a Systematic Investment Plan (SIP) or lump sum can impact the tax calculation. Lastly, the investor’s tax slab plays a vital role in the final tax outcome.

How Do You Earn Returns in Mutual Funds?

In mutual fund investing, returns are primarily generated through capital appreciation and dividend income. Capital appreciation refers to the increase in the value of your investments over time, while dividends are periodic payouts by the fund. However, investors must note that these gains are subject to mutual fund taxation, making it important to assess the post-tax return while choosing a fund. Always evaluate whether the mutual fund return taxable component aligns with your financial goals.

Taxation of Dividends Offered by Mutual Funds

Dividends received from mutual funds are added to the investor’s total income and taxed as per the applicable income tax slab. This means there is no separate rate for dividend income; it simply increases your taxable income. As per the latest mutual fund tax rules, mutual fund houses deduct a TDS (Tax Deducted at Source) of 10% if the dividend payout exceeds INR 5,000 in a financial year.

Taxation of Capital Gains Offered by Mutual Funds

Capital gains arising from mutual funds depend on the type of fund and the duration for which the investment is held. In equity mutual funds, short-term capital gains (less than 12 months) are taxed at 20%, while long-term gains (over INR 1.25 lakh after one year) are taxed at 12.5%. Debt funds, however, are taxed  as per the investor’s income slab, in line with existing mutual fund tax rules.

Tax Rates for Short-Term and Long-Term Capital Gains

Taxation on mutual fund gains is classified as short-term or long-term. In the case of equity funds, short-term capital gains are taxed at 20%, while long-term capital gains exceeding INR 1.25 lakh are taxed at 12.5% without indexation. Debt mutual funds follow different rules—gains are added to income and taxed as per slab. Understanding these mutual fund tax norms is essential for effective tax planning.

Taxation of Capital Gains When Invested Through SIPs

When you invest in mutual funds via a SIP, each instalment is treated as a separate investment for tax purposes. Hence, capital gain tax for mutual funds invested through SIPs is calculated based on the holding period of each contribution. If an instalment is redeemed within one year (equity), it is taxed as short-term; otherwise, long-term rates apply. Accurate tracking of investment dates is key to determining the mutual fund return taxable amount.

How Much Mutual Fund Investment Is Tax-Free?

Equity mutual fund investments are tax-free if long-term capital gains do not exceed INR 1.25 lakh in a financial year. Dividends, however, are fully taxable. Although there are no absolute tax-free mutual funds, investors can reduce liabilities by investing in tax saving mutual funds, which offer deductions under Section 80C of the Income Tax Act.

How Do I Avoid Tax on Mutual Funds?

While tax cannot be entirely avoided, it can be minimised. Holding equity funds for over a year reduces tax rates. Consider tax saving mutual funds that offer tax deductions and invest through SIPs to spread gains over years. Planning redemptions smartly and using exemptions effectively are key strategies for tax optimisation.

How Much Tax Do I Pay on Mutual Funds?

Your tax on mutual fund investments depends on the type of fund and how long you hold it. Equity funds attract 20% for short-term gains and 12.5% for long-term (beyond INR 1.25 lakhs). Debt funds are taxed based on your income bracket. Dividends are taxed as income. Being aware of capital gain tax for mutual funds helps in estimating potential liabilities in advance.s soon as we start earning a taxable amount of money, the first thing that comes to mind is the amount of money being paid as taxes. Given the norms on mutual fund taxation, investing in mutual funds is one of the best avenues for you to enjoy the stability and returns you desire to meet your financial goals. However, it can often happen that the gains that you make and the amount of money that is credited to your account differs. This is usually due to taxation. To put it simply, all income that you earn, including the income generated from your mutual fund investments, is subject to taxation. Understanding mutual fund taxation can help you plan your mutual fund investments better.

Hybrid fund and SIP taxation

Now let us move to the taxation of capital gains on hybrid funds. Hybrid funds are mutual fund schemes which have components of both equity and debt in their assets. When you invest in hybrid funds, your capital gains tax depends on the portion of equity and equity-related instruments in the portfolio. If the equity exposure of the scheme is higher than 65%, then your capital gains will be taxed in line with equity funds. If the equity exposure is below the benchmark of 65%, then your investment returns will face taxes in accordance with the norms governing debt funds. Therefore, if you are investing in hybrid funds with the aim of enjoying tax benefits available on equity funds, do check the exposure before you take a decision.

The next question is how much tax you will be charged, if you invest in mutual funds via systematic investment plans or SIPs. When you invest via SIPs, you purchase a certain amount of units every time. If you are holding your units for a period of one-year, from the time of first purchase, your gains will be taxed according to the long term capital gains norms. Therefore, if your capital gains are below 1 lakh rupees, you need not pay any tax. Your lumpsum amount investments will be taxed in line with the details mentioned above.

So, these are the details you need to know about the taxation on mutual funds. Based on these aspects, and your tax requirements, you can choose to invest in equity, debt or hybrid funds. You can also choose which mode you want to invest through – SIP or lumpsum. However, one thing you can be certain about is that mutual fund investments are an excellent way to earn returns while also saving on the tax you pay on these returns.

An investor education initiative by Edelweiss Mutual Fund

All Mutual Fund Investors have to go through a one-time KYC process. Investors should deal only with

Registered Mutual Fund (RMF). For more info on KYC, RMF and procedure to lodge/redress any

complaints, visit - https://www.edelweissmf.com/kyc-norms   

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS. READ ALL SCHEME-RELATED DOCUMENTS CAREFULLY