Mutual funds taxation in India depends on several factors, including the type of fund and the holding period. Equity and debt mutual funds are taxed differently, and the applicable tax rate can vary depending on whether the gains are classified as short-term or long-term capital gains.
As per income tax rules, equity-oriented mutual funds are taxed at 20% for STCG and 12.5% for LTCG above ₹1.25 lakh. Meanwhile, debt-oriented mutual funds purchased after April 1, 2023, are taxed at your income tax slab rate, regardless of how long you have held the fund.
Difference between equity and debt mutual funds
As per AMFI (Association of Mutual Funds in India), equity-oriented mutual funds are those that invest at least 65% of their assets in equity shares of domestic companies. This category includes diversified equity funds, sectoral and thematic equity funds, equity index funds, among others.
Debt mutual funds invest in fixed-income instruments such as bonds, government securities, treasury bills, among others. If a fund has 35% or less exposure to domestic equities, it is treated as a non-equity fund even if the fund is a gold or international fund). This category covers pure debt funds, liquid or ultra-short funds, fixed maturity plans (FMPs), and Gold ETFs, among others.
Tax treatment of equity vs debt mutual funds
Equity mutual funds are taxed based on the holding period of the investment. Gains earned on units sold within 12 months are treated as STCG and taxed at 20%. If the unites are held for more than 12 months, the gains qualify as LTCG and are taxed at 12.5% on gains exceeding ₹1.25 lakh in a financial year, while LTCG up to this limit remains exempt from tax.
For debt mutual funds purchased on or after April 1, 2023, the taxation rules are different. Irrespective of the holding period, gains are taxed according to the investor's applicable income tax slab rate. These funds no longer enjoy the indexation benefit or concessional long-term capital gains tax treatment that was available earlier. However, for investments made before that date, gains are taxed as LTCG at 12.5% if held for more than 2 years, and as short-term capital gains at slab rates if held for 2 years or less.
Taxes on dividends offered by MFs
Earlier, mutual fund houses paid the Dividend Distribution Tax (DDT) before disbursing dividends to investors. However, after the abolition of DDT, dividends received from mutual fund schemes are now taxable in the hands of investors and must be reported under the head "Income from Other Sources." Such dividend income is taxed as per the person's tax slab rate.
Further under Section 194K of the income tax act, mutual funds are required to deduct tax deducted at source (TDS) at 10% if the total dividend payout to an investor exceeds ₹10,000 in a financial year.
Which ITR should be filled?
An individual generally needs to file ITR-2 to report mutual fund capital gains. However, if you run a business or freelance and have capital gains after selling your mutual fund units, then you will need to file ITR-3.
Yes, if your Long-Term Capital Gains (LTCG) from listed equity shares and equity mutual funds (under Section 112A) are up to ₹1.25 lakh, you can also file ITR-1 (Sahaj), as per income tax rules.