All about taxation in mutual funds



Mutual funds have turned out to be one of the most sought investment options for discerning investors keen to grow their wealth. However, it is wise to know the implications of tax on mutual funds and the benefits of smart financial planning. In mutual funds, taxation is on the gains you make from your investment. Here are some factors that determine the taxes levied on mutual funds.


Factors that determine taxation on mutual funds in India


1. Type of Fund: For the purpose of taxation, mutual funds are classified into debt funds and equity mutual funds.


2. Capital Gains and Dividends: The taxation regime depends on the type of gains generated out of the funds. The two types of profit you may make from mutual funds are capital gains or dividends. Capital gains are when you sell a capital asset at a profit. On the other hand, dividends are the share of profits distributed by the fund manager out of the fund’s positive returns.


3. Holding Period: As per provisions of the Indian Income Tax Act 1961, Sec 196A, which deals with mutual funds, the duration of the holding period decides the quantum of tax that you need to pay.


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Debt mutual fund taxation


Debts are that type of mutual fund where more than 65% of the portfolio is invested in debt instruments. If you happen to redeem your debt mutual funds within a period of 36 months, you get a short-term capital gain. These gains are added to your taxable income and taxed at the applicable income tax slab. If you move up the slab due to the accrued capital gains, you are liable to pay a higher income tax.


If you sell your debt mutual funds after three years, you get long-term capital gains. The income tax applicable for long-term capital gains is at a rate of 20%. Over and above the tax, you have to pay a cess and a surcharge.


Hybrid mutual funds taxation


Mutual funds where the investment is over various asset classes are called hybrid funds. The objective of such funds is to spread the risk over different asset classes to mitigate the risk.


The rate of taxation on a hybrid fund depends on its composition. If the portfolio has more than 65% equity participation, it is treated and taxed like an equity mutual fund. If equity participation is less, the hybrid fund is treated as a debt fund for taxation purposes.

As an investor in a hybrid fund, you must be absolutely clear on its composition That way, you will be more aware of the impending tax burden.


Taxation on SIP mutual funds


Systematic investment plans (SIP) do not involve large, lump-sum amounts. Under SIP, you keep on investing small amounts in mutual fund schemes. The periodicity of the SIP may be weekly, monthly, quarterly, or half-yearly.


Under SIP, if you hold on for a period of one year, you have a long-term capital gain on the same. However, if the payments are less than Rs. 1 lakh, it is exempt from tax. But if you have profited by short-term capital gains on SIP units, the same is taxable at the rate of 15%. Regardless of your income tax slab, the tax will be the same. In addition to the tax, you must pay cess and surcharge.




Mutual funds are attractive investments that yield substantial returns to fulfill your financial goals. However, you need to be very sure before investing your hard-earned money. The type of funds, the returns, and the eventual tax liability should be very clear to you before you actually invest. The various funds and their tax structures are a complex activity that may not be your cup of tea.


Also, you may not have the time to research all available options and their implications. As an investor, you require an expert who can provide you with the necessary advice in this regard.


As updated on May 3rd, 2023.



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