Taxation of Mutual Funds: What Every Investor Needs to Know - STCG, LTCG, Dividend Income and ELSS

When you invest in mutual funds, the tax you pay depends on some key factors. These factors decide:

• How your capital gains are classified 

  and

• What rate of tax applies to them

Learn about these factors from the table below:

As per the latest amendments introduced in the Union Budget 2025, if you stay invested in equity-oriented funds for more than 12 months,  your gains are classified as “long-term” and taxed at a lower rate (explained in the next section). 

However, if you sell before 12 months or invest in debt-oriented funds, your gains are taxed as per your applicable income tax slab rates. For more clarity, check out the latest holding periods through the table below:

As per the current Income Tax rules, for equity mutual funds, gains are divided into short-term (less than 12 months) and long-term (12 months or more). But for debt funds, the rules changed after 31st March 2023. 

Any debt mutual fund bought on or after this date is taxed as short-term, no matter how long you hold it. Now, this means the profit from such funds will be added to your income and taxed as per your slab.

For more clarity, check out the latest short-term and long-term capital gains tax brackets for 2025: 

As an investor, you must understand that after the new rule, only mutual funds investing more than 65% in equity and equity-related instruments can qualify for LTCG tax benefits.

For debt-heavy funds (more than 65% in debt and money market instruments ), all gains are now treated as short-term and taxed as per your income slab. To avoid manual calculations and calculate tax accurately, you can even use an online capital gains calculator. 
 

• The STCG tax arising from selling listed equity shares, equity-oriented mutual funds, and business trust units within 12 months has increased from 15% to 20%. Other short-term assets continue to be taxed as per your income slab.

• The tax exemption limit on long-term gains from equity and equity-oriented funds has increased from ₹1 lakh to ₹1.25 lakh per financial year. However, the tax rate on gains above this limit has also gone up from 10% to 12.5%.

• Hybrid mutual funds that invest up to 65% in debt and money market instruments (not pure equity or pure debt) are now taxed at 12.5% without indexation benefits.

• From 23 July 2024, indexation benefits (used to reduce tax by adjusting purchase cost for inflation) are no longer available.

   

For those unaware, dividends are the portion of profits that mutual fund houses share with investors. Earlier, these dividends were tax-free in the hands of investors because fund houses paid a Dividend Distribution Tax (DDT).

However, since the Union Budget 2020, this system has changed . Now, in 2025, dividends are added to your total income and taxed as per your income tax slab. You need to report them under the head “Income from Other Sources” while filing your ITR.

Let’s see how dividend taxation works today:

• Tax at investor’s slab rate: 

  • Whether you receive dividends from equity, debt, or hybrid funds, the entire amount is treated as your income and taxed as per your slab rate.
     

• TDS (Tax Deducted at Source): 

  • If the dividend paid to you in a financial year exceeds ₹10,000, the fund house deducts 10% TDS before crediting the amount to your bank account. 

  • This TDS can be adjusted while filing your income tax return.
     

• Advance tax applicability: 

  • If your total tax liability (including on dividend income) exceeds ₹10,000 in a financial year, you are required to pay advance tax .
     

A tax-saving mutual fund is also called an Equity Linked Savings Scheme (ELSS). It is a special type of mutual fund that lets you save on income tax under Section 80C of the Income Tax Act (only under the old regime). 

By investing in an ELSS, you can claim a deduction of up to ₹1.5 lakh from your taxable income in a financial year. An ELSS scheme primarily invests in equity and equity-related instruments and is taxed as an “equity fund”. 

More importantly, this scheme comes with a mandatory lock-in period of 3 years. You cannot withdraw your investment before this duration. 

Thus, at the time of redemption, your gains are classified as long-term capital gains (as you have already held the ELSS for more than 3 years). Next, LTCG exceeding ₹1.25 lakh in a financial year is taxed at 12.5% as per current rules. Gains below this limit are tax-free!

If you are looking to invest in a tax-saving mutual fund, Tata Mutual Fund™ offers the Tata ELSS Fund. It is an open-ended equity-linked savings scheme with a statutory lock-in of 3 years and tax benefits.  The investment objective of the scheme is to provide medium to long-term capital gains along with income tax relief to its unitholders .

However, there is no assurance or guarantee that the investment objective of the scheme will be achieved. As an investor, you can start investing in this scheme with an SIP or a lump sum amount of just ₹500. 

So, after the latest changes introduced by the Union Budget 2025, equity mutual funds are now taxed at 20% for short-term gains (holding less than 12 months) and 12.5% for long-term gains (holding over 12 months). Also, you get an LTCG tax exemption of up to ₹1.25 lakh per year. 

Whereas, if we talk about the tax on debt mutual fund (more than 65% in debt and money market instruments), the gains are now always taxed at your income tax slab rate, regardless of the holding period. 

Next, for hybrid funds, taxation depends on their equity allocation. Mutual fund schemes investing over 65% in equity are treated as equity funds, while others are taxed as debt funds. Additionally, dividend income from mutual funds is now fully taxable under the head “Income from Other Sources.”

If you’re planning to invest in mutual funds, Tata Mutual Fund™  offers several schemes, such as equity, debt, ELSS, index, gold ETFs, and more. All the options are available as “direct” and “regular” plans with growth and IDCW variants.