Tax on Mutual Funds in India: A Complete Guide

Direct answer: Equity funds (>65% domestic equity) held over 12 months pay 12.5% LTCG above a ₹1.25 lakh annual exemption; under 12 months, 20% STCG. Debt funds — schemes holding more than 65% in debt and money market instruments — are taxed at your income slab rate regardless of holding period, following the April 2023 change. Gold funds and international/overseas funds of funds were swept into that same slab-rate net in 2023, but came back out of it from FY 2025-26 and now pay 12.5% LTCG once the holding period is cleared. Both the equity rates and the debt-fund slab-rate treatment were left unchanged by the Finance Act, 2026.

Mutual fund taxation changed significantly in recent years. Getting this wrong leads to unexpected tax bills at redemption time. Here's the current framework.

The Two Types of Mutual Fund Gains

Capital Gains: Profit from selling fund units (unit price at sale minus purchase price)

• Short-Term Capital Gains (STCG): Held for less than the qualifying period
• Long-Term Capital Gains (LTCG): Held for the qualifying period or more

Dividend Income: Distributions made by the fund to investors

Equity Mutual Fund Taxation

Qualifying period: 12 months (1 year)

Equity funds: any fund with more than 65% in domestic equities (equity diversified funds, ELSS, large-cap, mid-cap, small-cap, index funds tracking Indian equity indices).

The ₹1.25 lakh LTCG exemption: Each financial year, the first ₹1.25 lakh of long-term capital gains from equity is tax-free. Gain above that is taxed at 12.5%. This resets every April 1.

Tax harvesting opportunity: If you have unrealised equity gains below ₹1.25 lakh, you can redeem and reinvest before March 31 to "use" the annual exemption, resetting your cost basis. No tax is payable on gains within ₹1.25 lakh.

Debt Mutual Fund Taxation (Post-April 2023)

After the Finance Act 2023 changes:

Debt funds: liquid funds, short-duration funds, corporate bond funds, gilt funds, dynamic bond funds.

The old 3-year LTCG at 20% with indexation no longer applies. Debt fund gains are now equivalent to FD interest from a tax perspective. For investors in the 30% bracket, this eliminated the former tax advantage.

One carve-out survives, and it matters on older folios: the slab-rate rule bites only on units acquired on or after 1 April 2023. Units bought before that date and still held fall under ordinary capital gains rules — long-term after 24 months (12 months if the units are listed on an exchange), taxed at 12.5% without indexation. Check the acquisition dates on your capital gains statement before assuming slab rate across a whole holding.

International/Overseas Fund Taxation

This one changed, and a lot of older write-ups still carry the previous answer. Between April 2023 and March 2025, an overseas fund of funds (a Nasdaq 100 FoF, say) was taxed as a debt fund, because the "Specified Mutual Fund" test then keyed off how little domestic equity a scheme held. From FY 2025-26 the test keys off the opposite thing — whether the scheme holds more than 65% in debt and money market instruments — and an overseas equity FoF does not. Ordinary capital gains rules apply to it again:

• Held 24 months or less: gain added to your income, taxed at your slab rate
• Held more than 24 months: LTCG at 12.5%

The clock is 24 months rather than 12 because FoF units are not listed on an Indian exchange. And there is no ₹1.25 lakh exemption here — that belongs to equity funds alone.

Gold ETF / Gold FoF Taxation

Same story as overseas FoFs: the 2023 slab-rate treatment lapsed from FY 2025-26, because a gold scheme holds gold, not debt and money market instruments. What differs between the two wrappers is the holding period:

• Gold ETF (units listed and traded on NSE/BSE): long-term after 12 months, LTCG at 12.5%; at or under 12 months, slab rate
• Gold FoF (unlisted units of a fund that itself holds a gold ETF): long-term after 24 months, LTCG at 12.5%; at or under 24 months, slab rate

Neither gets the ₹1.25 lakh exemption.

Sovereign Gold Bond (SGB) Taxation

• Interest (2.5% p.a.): Taxed at slab rate
• Capital gains on redemption at maturity (8 years): exempt, but from tax year 2026-27 only for the original subscriber — the Finance Act, 2026 rewrote the exemption so that it applies only where an individual held the bond from the date of original issue right through to maturity. In exchange, it now covers every SGB series rather than only the 2015 scheme
• Bought on the exchange rather than at issue: that maturity exemption is no longer available to you
• Exit through the secondary market at any time: capital gains apply — LTCG at 12.5% after 12 months, since SGBs are listed securities

Hybrid Fund Taxation

Based on equity exposure:

• More than 65% equity → taxed as equity fund (12 months LTCG at 12.5%)
• Less than 65% equity → taxed as debt fund (slab rate)

Balanced Advantage Funds and Multi-Asset Funds: check the fund's average equity allocation to determine applicable tax treatment.

Dividend Taxation

Since April 2020:

• All mutual fund dividends are taxable at investor's slab rate
• TDS of 10% is deducted by the AMC once IDCW paid to you crosses ₹10,000 in a financial year (it was ₹5,000 until 31 March 2025); the limit runs per fund house, not per scheme
• Dividend income is added to your total income in the year received

Implication: Growth option is generally more tax-efficient than dividend option for wealth accumulation. Dividend withdraws money from the fund (reducing NAV), triggers slab-rate tax, and breaks compounding. Redeem from growth option only when you need money.

Practical Tax Planning Tips

1. For equity SIPs: hold units for at least 12 months + 1 day before redeeming to get LTCG rates
2. Annual tax harvesting: redeem equity fund gains up to ₹1.25 lakh annually if you have unrealised gains, reinvest immediately
3. Debt fund alternatives: for short-term parking with better tax efficiency, consider bank FDs (same slab-rate tax but potentially higher rates), or arbitrage funds (taxed as equity funds, providing FD-like returns with lower tax)
4. Choose growth over dividend for long-term wealth building
5. Keep track of purchase lots — SIP investors have multiple lots with different purchase dates

Detailed Worked Examples

Example 1: Equity SIP Redemption

Rahul ran a ₹10,000/month SIP in an equity index fund for three years, from April 2022 to March 2025. He redeems the entire corpus in May 2026.

At redemption in May 2026:

• Units from April 2022, the first instalment: held 49 months → LTCG (above 12 months ✓)
• Units from March 2025, the last instalment: held 14 months → LTCG ✓
• All 36 monthly instalments qualify as LTCG — the youngest lot has cleared 12 months

Total invested: ₹10,000 × 36 = ₹3,60,000 Redemption value: ₹5,40,000 (hypothetical) Total LTCG: ₹1,80,000

Tax calculation:

• LTCG exemption: first ₹1,25,000 is tax-free
• Taxable LTCG: ₹1,80,000 − ₹1,25,000 = ₹55,000
• Tax at 12.5%: ₹6,875
• Plus 4% cess: ₹275
• Total tax: ₹7,150

If Rahul had instead redeemed a month earlier, in April 2026, the LTCG tax would be identical — once every instalment has crossed 12 months, holding longer changes nothing about the rate. The 12-month qualifying period for equity is the only threshold that matters. Redeem before the youngest lot clears it, though, and that slice is taxed as STCG at 20%, as in the next example.

Example 2: Partial SIP Redemption — LTCG vs STCG Mix

Meena started a ₹15,000/month equity SIP in January 2026. She redeems ₹1,80,000 worth of units in February 2027 (13 months after starting).

Under FIFO (first in, first out):

• January 2026 units: 13 months old → LTCG
• February 2026 units: just past 12 months → LTCG (barely qualifies — equity needs more than 12 months, not exactly 12)
• March 2026 units onwards: less than 12 months → STCG

Depending on how many units are redeemed, some will be LTCG (12.5% above ₹1.25L) and some STCG (20%). The capital gains statement from the platform will split these automatically.

Example 3: Debt Fund vs FD Tax Comparison

Sunita (30% tax bracket) invests ₹5 lakh each in a debt mutual fund and a bank FD at the same 7% yield equivalent. She redeems/matures after 3 years.

Debt fund (purchased post April 2023):

• Gain at 7% compounded annually: ₹5,00,000 × 1.07³ = ₹6,12,522, so a gain of ≈ ₹1,12,500 over 3 years
• Tax at 30% slab: ₹33,750 (plus 4% cess)

Bank FD at 7%:

• Interest income over 3 years on the same compounding: ≈ ₹1,12,500
• Tax at 30% slab: ₹33,750 (plus 4% cess)

The rate is now identical. What still separates debt funds from FDs is returns, liquidity, credit risk and the timing of the tax — FD interest is taxed year by year as it accrues, while a debt fund is taxed only when you redeem.

The only remaining debt fund tax advantage: If you withdraw from a debt fund in a year when your income is lower (e.g., sabbatical, retirement year), the slab rate may be lower. You have more control over the year of redemption with a fund than with an FD which has fixed maturity.

Arbitrage Funds: The Tax-Efficient Hybrid

Arbitrage funds exploit price differentials between the cash and futures markets. They hold equity positions to qualify as equity funds (>65% equity exposure), but their risk profile is very low — almost like a liquid fund.

Tax treatment: Because they have >65% equity, they are taxed as equity:

• LTCG (>12 months): 12.5% above ₹1.25L
• STCG (<12 months): 20%

The planning use: For someone in the 30% slab who needs to park cash for 12+ months, an arbitrage fund held for 13 months is taxed at 12.5% LTCG vs 30% slab rate for a debt fund or FD. At high income levels, this is a significant difference. This also comes up for small business owners parking surplus working capital between GST payment cycles or a large receivable collection and its eventual redeployment — the same 12-month-plus horizon and tax treatment apply, though business cash should stay liquid enough that a redemption is never forced before the fund's exit-load window closes.

Expected returns from arbitrage funds track short-term money-market rates — broadly the policy repo rate, less fund expenses. That anchor moves with the rate cycle: the RBI policy repo rate stood at 5.25% as at 3 September 2026, well below where it sat a few years ago, so check the prevailing rate before carrying forward an old return assumption.

ELSS and Redemption Taxation

ELSS funds are equity funds with a 3-year lock-in per investment lot. On redemption after 3 years, gains are taxed as LTCG — 12.5% above ₹1.25 lakh per year. The ₹1.25 lakh LTCG exemption is shared across all equity fund redemptions in the financial year.

Important: If you've already booked ₹1.25 lakh of LTCG from equity shares or other equity funds earlier in the year, any ELSS redemption gains are fully taxed at 12.5% — the annual exemption is exhausted.

Reporting Mutual Fund Capital Gains in ITR

Mutual fund capital gains are reported in Schedule CG of ITR-2. You need:

1. Annual Capital Gains Statement from CAMS or KFintech — covers all mutual fund transactions
2. Most platforms (Zerodha Coin, Groww, Paytm Money) also generate a "Tax P&L" statement

The statement typically shows:

• Fund name
• Purchase date and NAV
• Redemption date and NAV
• Short-term gain/loss (STCG)
• Long-term gain/loss (LTCG)

Enter STCG in the "Short-Term Capital Gain from Equity/Equity MF" row and LTCG separately. The portal calculates tax automatically once you enter the amounts.

TDS on mutual fund redemptions: For resident investors, no TDS is deducted on mutual fund redemptions. You pay the tax at filing time. For NRI investors, TDS is deducted at source by the AMC.

Budget 2024 Changes Recap

For clarity on what changed and when:

Two different rules get muddled here, and the difference is worth money, so be precise about them.

The rate is set by the date you sell. The 10% rate applies only to a transfer that actually took place before July 23, 2024. Any redemption made on or after that date is taxed at 12.5% on the entire gain above the ₹1.25 lakh exemption, however long the units were held. A single gain is never sliced into a pre-2024 portion at 10% and a post-2024 portion at 12.5% — that split does not exist.

January 31, 2018 does something else entirely: it adjusts your cost, not your rate. For units acquired before February 1, 2018, the cost of acquisition is taken as the higher of what you actually paid and the lower of (a) the fund's NAV on January 31, 2018 and (b) your sale value. That grandfathering takes the gain accrued up to January 31, 2018 out of the reckoning; whatever gain is left is taxed at the single rate fixed by your sale date. Your capital gains statement applies both rules automatically.

One footnote on the table above: for FY 2024-25 the ₹1.25 lakh exemption applied across the whole year, including transfers made before July 23, 2024. It was the rate that changed mid-year, not the exemption — the ₹1 lakh figure is the position up to FY 2023-24.

Where this stands for FY 2026-27: the February 2026 budget left LTCG and STCG rates on equity and equity funds unchanged from the post-Budget-2024 levels, so the 12.5% / 20% / ₹1.25 lakh structure above is the one that applies to gains you realise in FY 2026-27. Treat "unchanged for two budgets running" as the current state of play, not as a rule that can no longer move — capital gains rates are set fresh in each year's Finance Act, so re-verify before large redemptions rather than assuming this table stays accurate indefinitely.

Limitations and What Else Can Change

A few boundaries on everything above: these are general tax mechanics, not advice tailored to your holdings — a CA should confirm anything involving a large redemption, an inherited folio, or NRI status, where the rules diverge from what's described here. Separately, and unrelated to any rate change: the Income-tax Act, 1961 was repealed on 1 April 2026 and replaced by the Income-tax Act, 2025, which renumbers sections (Section 112A's successor is Section 198 of the consolidated 536-section Act, and Section 111A's is Section 196) and replaces "Assessment Year" with "Tax Year." None of this changes the rates or holding-period rules in this article, and it had no effect on gains realised before 1 April 2026 or on the AY 2026-27 return covering them — it only becomes relevant when you file a Tax Year 2026-27 return, from mid-2027 onward.

Fund Switches and Taxation

A common misunderstanding: switching between schemes within the same AMC — such as switching from a regular plan to a direct plan, or switching between growth and dividend options — is treated as a redemption followed by reinvestment.

This means:

• The original units are sold at the current NAV on the switch date
• Capital gains arise if the NAV is above the purchase NAV
• New units are purchased at the current NAV, with a new cost basis

Example: You switch ₹2 lakh of equity fund units from regular to direct plan. The units were purchased 18 months ago at a lower NAV, and current value is ₹2.4 lakh — a gain of ₹40,000. Since you've held them more than 12 months, this is LTCG. If it's within ₹1.25L annual exemption, no tax. But the switch still triggers a reportable capital gains event.

Systematic Transfer Plans (STPs) — where you periodically move units from one fund (typically a liquid fund) to another (equity fund) — also trigger capital gains on each transfer. Monthly STP from a debt/liquid fund to an equity fund means 12 capital gains events per year, each taxed at slab rate (since liquid fund is a debt fund post-2023).

Always factor in the tax event before switching schemes, especially if holding period is below LTCG threshold.

Mutual Fund Dividends vs Growth: The Full Picture

Since April 2020, dividends from mutual funds are taxable at the investor's slab rate. The fund itself no longer pays Dividend Distribution Tax (DDT). Dividends appear in your income and are taxed accordingly.

TDS on dividends: The AMC deducts TDS at 10% once IDCW paid to you crosses ₹10,000 in a financial year — the threshold was ₹5,000 until 31 March 2025 — and it is counted per fund house, not per scheme. This TDS appears in Form 26AS and can be claimed as tax credit when filing ITR.

Growth vs IDCW (Income Distribution cum Capital Withdrawal): The "dividend" option has been renamed IDCW in mutual funds. The mechanics: the fund pays out a portion of gains from the NAV. Every distribution:

• Reduces NAV by the distribution amount
• Is taxable in your hands at slab rate
• Breaks compounding by removing money from the fund

When IDCW makes sense:

• Senior citizens in low tax brackets who need regular income
• Retirees who want periodic cash flows without going through the redemption process

For wealth accumulation: Growth option is almost universally better for working-age investors in higher tax brackets. The compounding impact of keeping returns inside the fund rather than paying slab-rate tax on distributions each year is significant over 10–20 year horizons.

LTCG Tax Harvesting: A Step-by-Step Example

Tax harvesting is the practice of redeeming equity fund units up to ₹1.25 lakh of gains and immediately reinvesting, to "reset" the cost basis and use the annual LTCG exemption.

Setup: You have ₹5 lakh invested in an equity fund since April 2023. Current value: ₹6.5 lakh. Unrealised gain: ₹1.5 lakh.

Harvest in March 2027 (FY 2026-27):

• Redeem units worth ₹6.5 lakh
• Realise LTCG of ₹1.5 lakh
• Apply ₹1.25 lakh exemption: ₹25,000 taxable LTCG
• Tax: ₹3,125 + cess = ₹3,250
• Immediately reinvest ₹6.5 lakh: new cost basis = ₹6.5 lakh

Without harvesting: If you held until the value grew to ₹8 lakh in a future year:

• LTCG = ₹3 lakh. Tax on ₹1.75 lakh above exemption = ₹21,875 + cess = ₹22,750

With harvesting: New cost basis is ₹6.5 lakh. If value reaches ₹8 lakh:

• LTCG from new base: ₹1.5 lakh. Below ₹1.25L exemption = only ₹25,000 taxable.
• Tax: ₹3,125 + cess = ₹3,250

Tax saved by harvesting: ₹22,750 − ₹3,250 (harvest tax) − ₹3,250 (later tax) = ₹16,250 saved.

The harvest strategy works best when you have significant unrealised gains, the gains are below or slightly above ₹1.25L, and you intend to stay invested (the reinvestment restores the position). Transaction costs (if any) and exit loads (some funds charge 1% if redeemed before 1 year) must be factored in.

Whether harvesting makes sense for your specific holdings is worth checking with a SEBI-registered investment adviser or your CA before you redeem anything.