When you build an investment portfolio, you should also understand how mutual funds are taxed. Different types of funds are taxed differently, and these tax rates can make some investments more suitable than others when it comes to optimising one’s tax outgo.
For example, a tax-free bond offering a 6% annual return may appear less rewarding than a fixed deposit giving 7% annual return. However once you account for tax on FD interest which could go up to 30% subject to meeting the tax threshold limit, the post-tax return may drop significantly, while the tax-free bond would still give a full 6% return on investment subject to market risks.
That’s why knowing the tax impact on your returns becomes crucial before investing. Being aware of how your mutual funds are taxed helps you make more efficient choices and stay compliant with the applicable tax laws. This article explains the key tax rules that apply to mutual fund investments.
What is Tax on Mutual Funds?
Tax on mutual funds is the rulebook that decides how your potential gains from a scheme are taxed in India. You can make money in two ways - capital gains when you sell or switch units at a higher NAV than you bought, and IDCW or dividend payouts when the fund distributes surplus.
Capital gains are taxed based on fund type and how long you held the specific units sold. IDCW or dividend payouts are taxed as income in your hands. Securities Transaction Tax (on equity-oriented funds) and stamp duty are transaction levies and separate from income tax.
What are the Factors to Determine Tax on Mutual Funds?
Fund type is the first filter. Equity-oriented schemes (generally holding at least 65% in Indian equities) follow equity capital-gains rules. Non-equity schemes include debt funds, gold/commodity funds, international equity funds, most fund-of-funds, and hybrids that don’t meet the equity threshold.
Holding period is the second filter. For equity funds, less than 12 months is short term and 12 months or more is long term. For most non-equity units bought on or after April 1, 2023, gains are taxed at slab rates regardless of holding period. Nature of return matters––capital gains vs dividends have different rates and timing.
Your tax slab and residential status decide surcharges, cess, and TDS. Capital losses can be set off and carried forward if you file returns on time.
When are you required to pay taxes?
You pay tax when a taxable event occurs. Selling or switching units is a sale for tax purposes, even if it is within the same fund house or from IDCW to Growth. Every SWP withdrawal sells units and can create capital gains or losses; in an STP, the transfer-out leg in the source scheme is taxable like any redemption.
IDCW or dividend payouts are taxable in the year of receipt or credit. If your total expected tax for the year (including mutual-fund taxes) crosses the advance-tax threshold, you must pay instalments to avoid interest. For resident individuals, TDS is not deducted on capital gains by domestic mutual funds, but it is deducted on IDCW or dividend payouts above the threshold and on most NRI redemptions at prescribed rates.
Categorisation of mutual fund taxation
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Equity-oriented funds (diversified equity schemes and qualifying hybrids with ≥65% in Indian equities) get equity capital-gains treatment.
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Non-equity funds (debt, gold, international equity, most fund-of-funds, and hybrids below the equity threshold) are taxed as non-equity.
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Units purchased on or after April 1, 2023 in non-equity categories are taxed at slab rates on redemption with no indexation, regardless of holding period.
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Units bought before April 1, 2023 continue to follow the legacy holding-period framework for classification, but for transfers on or after July 23, 2024, long-term gains are generally taxed at 12.5% without indexation. The special grandfathering relief for indexation mainly applies to land or building, not mutual fund units.
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ELSS are equity-oriented and have a three-year lock-in.
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Overseas equity funds and most FoFs are taxed as non-equity, even though they invest in equities.
How Do You Earn Returns in Mutual Funds?
There are two ways.
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Capital gains when you sell at a higher NAV than you bought.
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IDCW or dividend payouts if the fund declares and pays out part of its distributable surplus.
Each is taxed differently. Below is a quick example.
For example, you invest Rs. 2,00,000 in an equity fund at Rs. 100 per unit (2,000 units). After 18 months, the NAV rises to Rs. 120, and you redeem all units. Your capital gain is Rs. 40,000 (Rs. 120 – Rs. 100 × 2,000).
Since this is long-term equity (more than 12 months), the applicable tax rate is 12.5% on gains above Rs. 1,25,000 per financial year (for redemptions on or after July 23, 2024).
Here, Rs. 40,000 < Rs. 1,25,000, so LTCG tax = Rs. 0.
(STT is still paid by the fund house at exit—separate from your income tax.)
The categorisation of capital gains
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Equity-oriented funds
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Short-Term Capital Gain (STCG): Holding period < 12 months.
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Long-Term Capital Gain (LTCG): Holding period ≥ 12 months.
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Non-equity funds (debt, gold, international, FoFs, many hybrids)
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For investments made on/after April 1, 2023: Gains are taxed at your slab rate; no indexation; holding period label does not change the rate.
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For investments made before April 1, 2023: The holding-period distinction for those legacy units remains relevant, but for transfers on or after July 23, 2024, long-term gains are generally taxed at 12.5% without indexation.
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FIFO applies. When you redeem partially, the earliest-bought units are considered sold first for tax calculation.
Applicable tax rates for capital gains from mutual fund investments
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Equity-oriented funds
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STCG (≤ 12 months): 20% plus surcharge and cess (for transfers on or after July 23, 2024; previously 15%).
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LTCG (> 12 months): 12.5% on gains exceeding Rs. 1,25,000 in a financial year (no indexation), plus surcharge and cess (for transfers on or after July 23, 2024; previously 10% above ₹1 lakh).
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Non-equity funds (most debt/overseas/FoFs from 1 April 2023)
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All gains: Taxed at your income-tax slab rate plus surcharge and cess.
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No indexation benefit for new investments made on or after that date.
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Set-offs and carry-forward
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Short-term losses can be set off against both STCG and LTCG.
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Long-term losses can be set off only against LTCG.
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Unused capital losses may be carried forward for eight assessment years (subject to timely ITR filing).
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TDS
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For resident individuals, there is no TDS on capital gains from domestic mutual funds.
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For NRIs, TDS applies at prescribed rates on redemption proceeds.
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Taxation of IDCW/dividend income received from mutual funds
IDCW or dividend income from mutual funds is taxed in your hands at slab rates. Fund houses deduct TDS at 10% for resident individuals if the total income in respect of units paid or payable during the financial year exceeds Rs. 10,000.
For NRIs, TDS is deducted under specific sections and DTAA (Double Taxation Avoidance Agreement) relief might apply.
Because IDCW payouts reduce the NAV, many long-term investors prefer the Growth option and withdraw via SWP or goal-based redemptions; these trigger capital gains tax only on units sold.
Disclaimer: The information stated herein is based on UTI Mutual Fund’s understanding of the tax laws [Income Tax Act 1961 as amended by Finance Act, 2026] and is only for the purpose of providing general information to the investors of the UTI Mutual Fund Schemes and is not exhaustive and investors are advised to read and understand the scheme related documents carefully. UTI Mutual Fund, UTIAMC, UTI Trustee Company Pvt. Ltd. shall not be responsible in any manner whatsoever including for any information given herein. The investors should not treat the contents herein as advice relating to legal, taxation, investment or any other matter and are advised to consult its/his or her own tax/legal consultant with respect to the tax implications arising out of his or her or their participation in the Schemes.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.