Equity Funds: The Core Rules
For tax purposes, a mutual fund is considered 'equity-oriented' if it invests at least 65% of its portfolio in domestic company stocks. The tax rules here depend entirely on your holding period. If you sell your units within 12 months, the profit is a Short-Term
Capital Gain (STCG) and is taxed at a flat rate of 20%. If you hold your investment for more than 12 months, the profit becomes a Long-Term Capital Gain (LTCG). For FY 2026-27, the first ₹1.25 lakh of LTCG from equity funds in a financial year is completely tax-free. Any gain above this limit is taxed at a rate of 12.5%, with no benefit of indexation.
Debt Funds: The New Tax Reality
The taxation landscape for debt funds has changed significantly. For any investment made in a debt fund on or after April 1, 2023, the distinction between short-term and long-term gains has been removed. All capital gains from these investments, regardless of how long you hold them, are added to your total income and taxed at your applicable income tax slab rate. This change, introduced by the Finance Act 2023, effectively treats returns from new debt fund investments similarly to bank fixed deposit interest for tax purposes. The benefit of indexation, which used to lower the taxable gain on long-term holdings, is no longer available for these investments.
What About Older Debt Investments?
If you invested in debt funds before April 1, 2023, the old tax rules continue to apply to those specific units. However, the tax rates have been updated. If you hold these units for more than 36 months, they are considered long-term. The gain on selling these long-held units is taxed at 12.5%, but without the benefit of indexation for transfers made after July 23, 2024. If you sell units held for 36 months or less, the gain is treated as short-term and taxed at your income slab rate.
Hybrid and Other Fund Categories
The tax treatment for hybrid funds depends on their equity allocation. If a fund invests 65% or more in domestic equities, it is taxed just like an equity fund. If its equity exposure is less than 65% (but more than 35%), it is taxed like a debt fund. For units acquired after April 1, 2023, this means gains will be taxed at your slab rate. This rule also applies to what are called "Specified Mutual Funds," which include funds with not more than 35% invested in Indian equities, such as some conservative hybrid funds and international funds. Gold and Silver ETFs, however, now qualify for the more favorable equity-like tax treatment of 12.5% LTCG after a 12-month holding period, as of FY 2025-26.
Understanding Dividend Taxation
The era of tax-free dividends is long gone. Since April 1, 2020, any dividend income you receive from a mutual fund, whether equity or debt, is added to your total taxable income and taxed according to your income tax slab rate. Furthermore, if your dividend income from a single fund house exceeds ₹5,000 in a financial year, the fund house is required to deduct Tax at Source (TDS) at a rate of 10% before paying you. This TDS can be claimed as a credit when you file your income tax return.
