Posted on December 31, 2025 under Mutual Funds by Kaashika Jaiswal
Tax on Mutual Fund: Rules, Rates and Strategies
By Lakshmishree | Updated: December 2025
What is the Tax on Mutual Funds?
Tax on mutual funds is the tax you pay on the returns earned from your mutual fund investments. This tax applies when you sell (redeem) your mutual fund units at a profit or when you receive dividends. In India, how much tax you pay depends mainly on three things: the type of mutual fund (equity, debt, or hybrid), how long you stay invested, and in some cases, the date when you bought the fund.
Earlier, mutual fund taxation was simple, with fixed tax rates. Today, the rules have changed. For example, debt funds bought before and after April 2023 are taxed differently, and equity funds now follow a new 12.5% long-term tax rate with a higher exemption limit. Because of these changes, understanding mutual fund taxation has become important for every investor who wants to avoid tax surprises and keep more of their returns.
Table Of Content
Mutual Fund Taxation: Old vs New Tax Rules
Mutual fund taxation in India has changed significantly, making old strategies obsolete. Tax liability now depends on fund type, holding duration, and purchase date.
Debt funds bought after April 1, 2023, are taxed at the investor's income slab as short-term assets (Section 50AA). Equity long-term capital gains are taxed at 12.5%, with an increased annual exemption of ₹1.25 lakh. The indexation benefit is removed for legacy debt funds sold after July 23, 2024.
To navigate these new regulations effectively, investors should focus on three essential points:
Verify the Purchase Date: Always confirm the date your mutual fund units were acquired.
Determine Fund Classification: Understand whether your fund is categorized as equity, hybrid, or debt based on its equity exposure.
Strategic Redemption Planning: Carefully plan your redemptions to maximize the use of available exemptions and benefit from lower tax rates.
By making these points central to their investment approach, investors can more effectively navigate the new tax landscape and manage their income tax liabilities on mutual funds.
Types of Mutual Funds and Their Tax Treatment
The tax on different types of mutual funds in India depends on what the fund invests in. Mutual funds are mainly grouped into equity, debt, and hybrid funds based on how much equity they hold. This grouping is important because it decides whether your gains are taxed at fixed capital gains rates or added to your income and taxed as per your tax slab.
Tax on Equity Mutual Funds
Equity mutual funds invest at least 65% of their money in Indian shares. If you hold these funds for more than 12 months, your profit is treated as long-term and taxed at 12.5% plus cess. You also get a benefit of the first ₹1.25 lakh of long-term gains in a year is tax-free.
If you sell equity fund units within 12 months, the gains are short-term and taxed at 20% plus cess. Because long-term tax is lower and comes with an exemption, equity mutual funds are best suited for investors who stay invested for a longer time.
Tax on Debt Mutual Funds: New vs Legacy Rules
Debt mutual fund taxation in India now depends mainly on when you bought the fund. This is different from equity funds. If a debt fund was purchased on or after April 1, 2023, it is always treated as a short-term investment. Any profit from such funds is added to your income and taxed as per your income tax slab, just like a fixed deposit. Holding these funds longer does not reduce tax, and there is no indexation benefit.
For debt funds bought before April 1, 2023, the rules changed from July 23, 2024. These older (legacy) investments become long-term after 24 months and are taxed at a flat 12.5% plus cess, but without indexation. Investors no longer have the option to choose 20% tax with indexation. This makes it important to check the purchase date before redeeming any debt mutual fund, as tax impact can differ sharply.
Tax on Hybrid, Gold & International Mutual Funds
Hybrid, gold, and international mutual funds invest 35% to 65% in equity, placing them between equity and debt funds. For these funds, gains become long-term only after a 24-month holding period. Long-term gains are taxed at 12.5% plus cess, and indexation is not available.
If these funds are sold before 24 months, the gains are treated as short-term and taxed as per the investor’s income tax slab. Because of this structure, they can be more tax-efficient than debt funds for medium-term investors, especially those in higher tax brackets, but holding period planning remains important.
Short-Term Capital Gain Tax on Mutual Funds
Short-term capital gain tax on mutual funds applies when you sell your mutual fund units within a short time after investing. Holding period varies by fund type.
For equity mutual funds, gains are treated as short-term if the units are sold within 12 months. These gains are taxed at 20% plus cess.
For debt mutual funds, short-term gains are added to your total income and taxed as per your income tax slab. This can cause a higher tax expense for investors in the 20% or 30% tax bracket.
Since short-term gains are taxed at higher rates, frequent buying and selling can reduce overall returns.
Long-Term Capital Gain Tax on Mutual Funds
Long-term capital gain tax on mutual funds applies when investments are held for a longer period before redemption.
For equity mutual funds, gains become long-term after 12 months and are taxed at 12.5% plus cess under Section 112A. Investors also get a major benefit, the first ₹1.25 lakh of equity long-term gains in a financial year is tax-free.
For debt mutual funds bought before April 1, 2023, long-term gains apply only if the units are sold on or after July 23, 2024 and held for more than 24 months. These gains are taxed at 12.5% plus cess without indexation.
For hybrid, gold, and international funds, gains become long-term after 24 months and are also taxed at 12.5% plus cess.
Fund Category
Short-Term Holding
ST Tax
Long-Term Holding
LT Tax
Equity
≤12 months
20%
>12 months
12.5% (₹1.25L exempt)
Debt (New)
Any period
Slab rate
NA
NA
Debt (Legacy)
≤24 months
Slab rate
>24 months
12.5%
Hybrid / Gold / Intl
≤24 months
Slab rate
>24 months
12.5%
Indexation Removal Effect in Mutual Funds Taxation
Indexation is the inflation shield where your original Cost of Acquisition is adjusted upwards by a government published inflation index (Cost Inflation Index - CII). This effectively lowers your taxable profit.
Example: You buy a unit for ₹100. Over 3 years, the CII rose 10% (Indexation). Your adjusted cost for tax is now ₹110. If you sell it for ₹120, your taxable gain is only ₹10 (₹120 - ₹110), not ₹20.
Its removal, even with a lower 12.5% tax rate, can significantly increase the effective tax liability for low-yield debt funds where indexation previously reduced the taxable gain to near zero.
Investor Clarity: For legacy units sold today, Debt Fund investors do not have a choice between the old 20% with indexation and the new 12.5% flat rate. The 12.5% flat rate without indexation is mandatory for legacy units sold on or after July 23, 2024.
How to Save Tax on Mutual Funds
Saving tax on mutual funds requires more than knowing tax rates. Real tax savings come from using the rules smartly and planning withdrawals at the right time. Below are some effective and legal strategies that can help reduce your overall tax on mutual funds and improve post-tax returns.
12.5% LTCG Advantage & Arbitrage Fund Strategy
12.5% long-term capital gains (LTCG) rate: It has become a powerful tax advantage for investors in higher income brackets. For someone in the 30% tax slab, interest income from fixed deposits or gains from new debt mutual funds is taxed at the full slab rate. In comparison, long-term gains from eligible mutual funds taxed at 12.5% act as a strong tax shield, helping investors retain a much larger portion of their returns.
Compared with fixed deposits, certain mutual fund categories such as hybrid funds offer better post-tax returns for medium-term investors. After a 24-month holding period, gains from hybrid funds are taxed at 12.5%, while FD interest is taxed every year at slab rates. This difference can lead to meaningful tax savings over time, especially for investors in the 20% and 30% tax brackets.
Arbitrage funds
It is another such fund advantage a step further. Although they follow a low-risk strategy, arbitrage funds are legally classified as equity-oriented mutual funds because they maintain at least 65% exposure to equity.
This allows investors to access the 12.5% LTCG rate after just 12 months, which is faster than hybrid funds.
Short-term gains in arbitrage funds are taxed at 20%, which is still lower than the slab rate for high-income investors of 30% slab rate. Because of this structure, arbitrage funds are often used as a tax-efficient alternative to short-term debt investments.
Tax Loss Harvesting
Tax loss harvesting is a strategy where you sell a mutual fund investment that is currently at a loss to reduce your taxable gains. The booked loss can be used to offset gains from other mutual funds. This strategy has become more valuable after the increase in the short-term capital gain tax on mutual funds to 20%.
A key rule to remember is the priority rule:
Short-Term Capital Loss (STCL) can be used to offset both short-term and long-term capital gains.
Long-Term Capital Loss (LTCL) can be used only to offset long-term capital gains.
After booking the loss, investors can reinvest the amount in a similar but not identical mutual fund to maintain market exposure.
Using the ₹1.25 Lakh LTCG Exemption Wisely
Equity mutual fund investors get an annual ₹1.25 lakh tax-free limit on long-term capital gains. Investors can plan redemptions in a way that long-term gains stay within this limit each financial year.
SWP vs Dividend: A Smarter Way to Withdraw
Choosing the dividend option can increase your tax burden, especially if you are in a higher tax slab. Dividends from mutual funds are added to your income and taxed as per your slab rate.
A better option is a Systematic Withdrawal Plan (SWP) from the growth plan. Under SWP, only the capital gain portion of each withdrawal is taxed, while the invested principal remains tax-free. If the investment qualifies for long-term capital gains, the tax rate can be as low as 12.5%, making SWP far more tax-efficient than dividends for regular income needs.
Calculating mutual fund redemption tax follows a clear step-by-step process. The tax is not calculated on the entire redemption amount, but only on the profit (capital gain) you make from the investment. The final tax depends on the fund type, holding period, and in some cases, the purchase date.
Step 1: Calculate Capital Gain (Capital Gain = Redemption Value – Purchase Cost)
Step 2: Check the Holding Period
Equity mutual funds: Equity Mutual Funds, a holding period of 12 months or less is classified as Short-term, while a period of more than 12 months is considered Long-term.
Hybrid, gold, and international funds: The holding period of up to 24 months is Short-term, and anything more than 24 months is Long-term.
Debt funds (new regime): Always treated as short-term
Debt funds (Section 50AA): Taxed as per income tax slab
Example: If you invest ₹2,00,000 in an equity mutual fund and redeem it after 18 months for ₹2,60,000, your capital gain is ₹60,000. Since the gain is below the ₹1.25 lakh exemption limit, no tax is payable on this redemption.
Following these steps makes it easier to calculate income tax on mutual funds accurately and avoid surprises at the time of filing your tax return. you can even use this information by checking a standard capital gain tax calculator.
Common Mistakes to Avoid While Paying Tax on Mutual Funds
Even well-informed investors often make avoidable mistakes when handling tax on mutual funds. These mistakes can increase tax liability or create compliance issues with the income tax department. Understanding and avoiding them is essential for managing mutual fund taxation correctly.
Ignoring the Holding Period
The holding period plays a critical role in deciding how your mutual fund gains are taxed. Redeeming units too early can turn long-term gains into short-term gains, which are taxed at higher rates. This is especially relevant for equity and hybrid mutual funds, where completing the required holding period can significantly lower the tax payable.
Not Reporting Capital Gains in the Tax Return
A common misconception is that capital gains do not need to be reported if the amount is small or if tax has already been adjusted. This is incorrect. All capital gains from mutual funds either short-term and long-term must be reported in your income tax return.
Misunderstanding Dividend Taxation
Many investors still assume that dividends from mutual funds are tax-free. In reality, dividends are fully taxable and are added to the investor’s total income. They are taxed according to the applicable income tax slab, which can make dividends an expensive option for investors in higher tax brackets. In such cases, capital-gain-based withdrawals like SWP are often more tax-efficient.
Conclusion
The key to mastering the mutual fund taxation rules in India is understanding three crucial factors: purchase date, fund type, and holding period. To minimize your tax liability, you must strategically plan redemptions, leverage the ₹1.25 lakh tax-free limit on long-term equity gains, and choose tax-efficient options like Arbitrage Funds and Systematic Withdrawal Plans (SWPs) over dividends. By being proactive and avoiding simple errors, you turn the complex tax landscape into an opportunity to maximize your post-tax wealth.
Q. Is tax on mutual fund investments is applicable on all type of mutual funds?
A. Yes, tax is applicable on mutual fund investments when you earn income from them. Tax is charged either at the time of redemption as capital gains or when dividends are received. Tax treatment depends on the type of mutual fund and the holding period.
Q. How much tax do I pay on mutual fund redemption?
A. The tax on mutual fund redemption depends on whether the gains are short-term or long-term and on the fund category. Equity mutual funds are taxed at 20% for short-term gains and 12.5% for long-term gains, while debt and hybrid funds may be taxed at slab rates or at 12.5%, based on current rules and purchase date.
Q. Are mutual fund returns tax-free?
A. No, mutual fund returns are not completely tax-free. While equity mutual funds offer an exemption of up to ₹1.25 lakh per year on long-term capital gains, returns beyond this limit are taxable. Dividends are always taxable as per the investor’s income tax slab.
Q. How is short-term vs long-term tax calculated?
A. Short-term or long-term classification depends on the holding period. Equity funds become long-term after 12 months, while hybrid and certain other funds require 24 months. Short-term gains are taxed at higher rates compared to long-term gains.
Q. Do I need to pay tax if I reinvest gains?
A. Yes, tax is payable even if you reinvest the gains. Once mutual fund units are redeemed and a profit is realised, then tax on mutual fund gain is deducted, regardless of whether the money is reinvested in another fund.
Disclaimer: This article is intended for educational purposes only. Please note that the data related to the mentioned companies may change over time. The securities referenced are provided as examples and should not be considered as recommendations.
Kaashika is a social media strategist and financial content creator at Lakshmishree. She specialises in simplifying complex IPO and stock market concepts into clear, easy-to-understand content. Having created over 500+ pieces of financial content across reels, blogs, website posts and digital creatives, Kaashika helps audiences connect with the world of finance in a more accessible and engaging way.
