Mutual Fund Taxation in India: Capital Gains, Dividends & Indexation

The Income Tax Act, 1961 classifies mutual funds primarily on the basis of their “equity exposure”, and this classification determines how capital gains are taxed.

After the latest amendments introduced under the Union Budget 2025, mutual funds in India now fall into two broad categories for tax purposes: 

• Equity-oriented funds and

• Other than equity-oriented funds

Let’s gain more clarity in this regard:

“Specified Mutual Fund” means
(a) a mutual fund scheme investing more than 65% in debt and money market instruments, or
(b) a fund of fund investing 65% or more in such mutual fund schemes.

The holding period refers to the length of time you stay invested in a mutual fund before selling your units. It determines whether your gains are classified as short-term or long-term. Understand that:

• Short-term capital gains (‘STCG’) are usually taxed at higher rates while

• Long-term capital gains (‘LTCG’) enjoy lower tax rates and exemptions

As per the Income-tax Act, 1961, the holding period differs based on the type of mutual fund, particularly whether the fund is equity-oriented or other than equity-oriented or a specified mutual fund. Let’s check out the latest holding period rules for mutual funds:

Before April 1, 2023, the taxation of other-than equity oriented mutual funds were largely influenced by how long an investor stayed invested. If an investor sold debt fund units within three years (36 months) of purchase:

• The gains were considered as STCG and

• Taxed according to the investor’s applicable income-tax slab rate

However, if the same investment was held for more than three years (36 months), the gains qualified as LTCG. These long-term gains were taxed at 20% with the indexation benefit. For those unaware, mutual fund indexation benefit is allowed investors to adjust the purchase cost of their investment for inflation. Such an adjustment significantly reduced taxable gains and, in turn, the final tax liability. 

This Taxation Rule Changed from April 1, 2023

For other-than equity oriented mutual fund (classified as Specified mutual fund) units acquired on or after April 1, 2023, the holding period no longer matters for tax purposes. As mentioned above, any gains arising from the sale, redemption, or maturity of these units are now always treated as STCG and taxed at the investor’s applicable slab rate (regardless of how long the investment is held).

Further, with effect from 23 July 2024, the holding period in the case of other-than equity oriented mutual funds (not classified as specified mutual funds) is also changed from 36 months to 24 months. 

Once you determine the holding period of your mutual fund investment and whether your gains are LTCG or STCG, the next step is to apply the correct capital gains tax rate. Let’s see how this happens:

A) Equity Oriented Mutual Funds

If you sell units of equity Oriented mutual funds within 12 months, your gains are treated as short-term capital gains (STCG) and taxed at 20% under section 111A of the Income-tax Act, 1961. Whereas, if you hold the units of such fund for more than 12 months, the gains become long-term capital gains (LTCG) and are taxed at 12.5%, with an annual exemption limit of ₹1.25 lakhs under section 112A of the Income-tax Act, 1961. 

Example

Since the units of the fund were held for more than 12 months, the gain qualifies as long-term capital gain (LTCG). Since the LTCG arising on sale of units of equity oriented mutual funds enjoys an annual exemption of ₹1.25 lakh, the tax payable is NIL. 

Now, let’s assume that the LTCG is ₹1,50,000. In this case, the first ₹1.25 lakh is exempt from tax. The remaining ₹25,000 is taxable at 12.5%, resulting in a tax liability of ₹3,125 [plus surcharge (as applicable) and health and education cess].

B) Other-than equity oriented Mutual Funds

In case of “specified mutual funds”, the holding period does not matter (for units purchased on or after April 1, 2023). The gains are always considered as short-term capital gains and taxed as per the applicable slab rate. 

Example 1: Specified Mutual Fund Units Acquired Before April 1, 2023

Since the units were held for more than 24 months, the gains qualify as LTCG and are taxed at 12.5% without indexation under section 112 of the Income-tax Act, 1961. Therefore, the tax calculation would be:

• LTCG = ₹3,00,000 - ₹2,00,000 = ₹1,00,000

• Tax @ 12.5% = ₹12,500 [plus surcharge (as applicable) and health and education cess]

Example 2: Specified Mutual Fund Purchased On or After April 1, 2023

The ₹1,00,000 capital gain would be added to the investor’s total income and taxed according to their applicable income-tax slab.

Based on the current provisions of the Income-tax Act, 1961, any income distributed by mutual fund houses in respect of units of mutual funds is fully taxable in the hands of the investor. Such income amount is:

• Added to the investor’s total income under the head “Income from Other Sources” +

• Taxed according to their applicable income-tax slab rate.

Furthermore, mutual fund houses deduct tax at source (‘TDS’) at the rate of 10% under section 194K of the Income-tax Act, 1961, in case of resident investors, if the total of such income paid exceeds ₹10,000 in a financial year. This TDS is not an extra tax! It is only a prepaid tax and can be claimed or adjusted while filing your income tax return (ITR).

So now you are aware of the latest mutual fund taxation rules in India and how they directly impact your investment returns. As an investor, the first step is to identify your holding period and determine the nature of your gains, whether they are short-term or long-term (depending on the type of mutual fund you have invested in). 

Once this is clear, you can apply the correct tax rate. For equity-oriented mutual funds, short-term capital gains are taxed at 20%, while long-term capital gains are taxed at 12.5%, subject to the annual exemption limit of ₹1.25 lakhs. 

In the case of specified mutual funds (for investments made after April 1, 2023), gains are taxed at the applicable income tax slab rate, irrespective of the holding period and without any indexation benefit. Lastly, income distributed in respect of units of mutual funds is added to your total income and taxed at your applicable slab rate. 

The views mentioned above are for information & educational purposes only and do not construe to be any investment, legal, or taxation advice. Investors must do their own research before investing. The views expressed in this article are personal in nature and in is no way trying to predict the markets or to time them. Any action taken by you on the basis of the information contained herein is your responsibility alone, and Tata Asset Management Pvt. Ltd. will not be liable in any manner for the consequences of such action taken by you. Please consult your Mutual Fund Distributor before investing. The views expressed in this article may not reflect in the scheme portfolios of Tata Mutual Fund. There are no guaranteed or assured returns under any of the schemes of Tata Mutual Fund.