Explaining how mutual funds are taxed


When you invest in mutual funds, you consider various points like expected returns, goals, time horizon, etc. but unfortunately most investors do not take into consideration tax implication of their mutual funds.

It is important to do so since they affect the overall returns and other decisions like the structure of your portfolio and the timing of your exit.

best mutual funds

How are mutual funds taxed? 

Mutual funds are taxed based on the asset classes they invest in.

There is one set of rules for equity mutual funds and another for debt mutual funds.

For the purpose of taxation, international mutual funds are considered as debt mutual funds.


Equity mutual funds

An equity mutual fund is a fund that invests primarily in shares of companies.

Since equity mutual funds carry the most risk among all mutual funds, they also have the potential to generate the highest returns.

For a fund to qualify as an equity mutual fund, it needs to invest 65% of its corpus in equities at all times.

Only tax saving mutual funds, also known as elss funds need to invest 80% of its corpus in equities at all times as opposed to 65% for other equity mutual funds.



Long term capital gains tax better known as LTCG is applied on equity mutual funds when the gains from equity mutual funds held for more than a year are more than 1 lakh.

The LTCG rate is 10%.

Capital gains up to 1 lakh are exempt for taxes.

There is no indexation benefit when calculating LTCG.



Short term capital gains tax better known as STCG is applied on gains from equity mutual funds which are held for 12 months or less.

The STCG rate is 15%.

There is no ceiling benefit in STCG like the 1 lakh ceiling in LTCG.

STCG is charged on from Re 1.

Additional reading: Click Here to read about the various types of equity mutual funds 



Hybrid Mutual Funds

Hybrid mutual funds are a mixture of equity, debt, cash, etc.

Any mutual fund scheme in the hybrid mutual fund category that holds 65% into equity will be treated as an equity mutual fund and will be taxed as one.

Examples include Equity savings fund and aggressive hybrid funds.

Funds that do not hold a minimum of 65% into equity will not be treated as an equity fund and therefore will not be taxed as one.

Example includes any conservative hybrid fund.

For multi asset mutual funds the taxation rules differ from scheme to scheme, this is because some schemes hold 65% into equities and some do not.

The ones who do not are taxed as debt mutual funds. 


Tax Saving/ELSS Mutual Funds

Tax saving/elss mutual funds allows you an exemption of up to 1,50,000 in your taxes under section 80c of the income tax act.

Tax saving funds have a lock in period of 3 years.

Elss funds need to invest a minimum of 80% of its overall portfolio into equities.

In case of sip plans, you have to keep in mind that each sip instalment completes 3 years in case you wish to redeem.


Are elss mutual funds also taxed?

Yes, elss mutual funds better known as tax saving mutual funds are also taxed as any other equity mutual fund.

They can only be charged LTCG since they have a lock in period of 3 years so therefore by default the holding period is more than a year.

Elss mutual funds allow you tax exemptions but the gains on them is not tax free.

Additional reading: Click Here to read our complete report on ELSS funds and how they work


Debt mutual funds

Debt mutual funds invest in government securities, debentures, corporate bonds, etc. unlike equity mutual funds which invests primarily in equity and equity related instruments.

They provide lower returns than equity mutual funds but more safety.

They are less volatile than equity mutual funds and are more suited for short term goals.




For debt mutual funds, long term capital gains tax is applied on gains from debt mutual funds held for more than 36 months.

The LTCG rate for debt mutual funds is 20% after indexation.



For debt mutual funds, short term capital gains tax is applied on gains from debt mutual funds held for less than 36 months.

Short term capital gains are added to your income and taxed as per your income tax slab.


Are you investing in the right mutual funds?

Taxation on SIP investments

SIP in mutual funds is a process by which you invest systematically a fixed amount in mutual funds either daily, weekly, monthly, quarterly, bi-annually or annually.

The taxation on sip mutual funds is more complicated and not as straight forward as compared to lumpsum investments in mutual funds.

Each SIP instalment is considered as a fresh investment and therefore each sip instalment is taxed accordingly.

Suppose you invest 5,000 on a monthly basis for 15 months after which you redeem the entire amount (invested amount + profits).

After 15 months if you stop and redeem the entire amount (invested amount + profits) only the profits of the first three months would be tax free since they have completed a year and not crossed 1 lakh in profits whereas the rest of the instalments would be charged STCG.


What is Indexation?

Indexation is a procedure by which the purchase price of an asset is adjusted according to inflation.

Therefore, indexation increases the purchase price of an asset.

This reduces the overall gains and in turn the taxes to be paid as well.


Taxes on International mutual funds

International mutual funds are taxed as debt mutual funds.

The taxation rules applicable on debt mutual funds are applicable on international mutual funds too.

It is the same for all international mutual funds irrespective of the geography.

Meaning a US based international mutual fund will be taxed in the same manner as a European, emerging markets or Asia based.


Are you investing in the right mutual funds?

Securities Transaction Tax

An STT of 0.001% is charged by the government on the sale of equity mutual funds and equity-oriented hybrid funds.

There is no STT charged on the sale of debt mutual funds.


Stamp Duty

From July 1, 2020 onwards a stamp duty of 0.005% is deducted on the investment amount of mutual funds for any transaction executed on or after July 1 2020.

This is applicable on:

  1. Purchases
  2. Dividend Reinvestments
  3. Systematic Investment Plan (Inclusive of running SIP’s registered earlier)
  4. Systematic Transfer Plan
  5. Equity as well as Debt schemes


A simple illustration to understand this better

Application Amount: 1,00,000

Stamp Duty: 0.005%

Stamp Duty Amount: 1,00,000 X 0.005% =Rs 5

Net Investment Amount (After deducting Stamp Duty) = 9,99,995

As can be seen by the above illustration, if you have a long term horizon then there’s not much to lose sleep over.


Tax on dividend received from Mutual Funds

Dividend Distribution Tax (DDT) has been abolished for mutual funds from 1st April 2020 as announced in the budget for 2020.

Earlier dividend received from mutual funds was tax free in the hands of the investor since tax for the same was already paid by the mutual fund in the form of Dividend Distribution Tax (DDT).

Due to this the dividend was received by an investor but the tax was paid by the mutual fund company.

With a fixed Dividend Distribution Tax rate, small and big investors alike ended up paying the same tax rate irrespective of the dividend amount.

Under the new rule now, effective 1st April 2020 onwards, dividend received from mutual funds is now added to investors income and gets taxed according to the investors tax bracket.

For example lets say Mr A received dividend Rs 10,000 on 25th August 2020 which is more than 5,000, he will pay a TDS of Rs 750 on the dividend income.

7.5% of 10,000 is 750, therefore he would receive Rs 9,250 which would then further be added to his taxable income for the financial year.

The standard rate for TDS on dividend income exceeding 5,000 is 10%, however the government has reduced that to 7.5% from 14 May 2020 to 31 March 2021 in light of Covid-19 crisis.

For portfolio enquiriesemail us with your doubts at info@themutualfundguide.com

Disclaimer : While due precaution has been undertaken in the preparation of this article, The Mutual Fund Guide or any of its authors will not be held liable for any investments based on the above article. The above article should not be considered financial advice and has been published only for your perusal. Due credit has been given in case wherever required, in case you feel any part violates any rights then do get in touch with us and we shall get it duly removed.  
Mutual Fund investments are subject to market risks. Please read the offer document carefully before investing

Copyright © 2021  The Mutual Fund Guide, All rights reserved 

My Instagram