Tax rules for mutual funds have been reshaped in recent years. The current framework depends on three key factors: the type of investor, the fund’s portfolio mix and how long the units are held. As Rajesh Gandhi, Partner at Deloitte India, explains, taxation hinges on whether the scheme is equity-heavy, debt-oriented or falls somewhere in between.
“Mutual fund taxation in India depends on three core factors, investor type (resident individual/HUF, non-resident, or domestic company), portfolio composition of the scheme (equity, debt, or other assets) and holding period of the investment”, Moneycontrol quoted Rajesh Gandhi as saying.
Before investing in equity, debt, hybrid, gold or international funds, it is important to check the asset allocation. Tax treatment follows the underlying exposure of the scheme.
Equity mutual funds: Long-term gets a benefit
Gandhi said that equity-oriented mutual funds and equity ETFs invest at least 65 per cent in listed domestic shares. If held for more than 12 months, gains qualify as long-term capital gains and are taxed at 12.5 per cent on profits exceeding Rs 1.25 lakh in a financial year. Gains within 12 months are treated as short-term and taxed at 20 per cent.
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“If a scheme invests more than 65 per cent in debt/money market instruments (i.e., direct debt exposure) or more than 65 per cent in other funds that themselves invest more than 65 per cent in debt (indirect debt exposure), it qualifies as a specified mutual fund. In such cases, the gains are deemed short-term and taxable at applicable rates/ slab rates, with no long-term capital gains benefit.”
Investments made on or before January 31, 2018, continue to enjoy grandfathering benefits, where gains up to that date are not taxed.
ELSS: Lock-in with tax deduction
Equity-linked savings schemes (ELSS) come with a mandatory three-year lock-in. Because of this, there is no short-term capital gains tax. Long-term gains above Rs 1.25 lakh are taxed at 12.5 per cent. ELSS investments also qualify for a deduction up to Rs 1.5 lakh under Section 80C for those following the old tax regime.
Debt funds: Purchase date is crucial
For debt-oriented or specified mutual funds, the date of purchase determines taxation.
Units bought on or after April 1, 2023, are taxed at the investor’s slab rate, regardless of holding period. Units bought before that date attract 12.5 per cent tax on long-term gains, subject to holding period conditions. Short-term gains are taxed at slab rates.
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Hybrid, gold and international funds
Hybrid funds are taxed based on equity exposure. If equity allocation is 65 per cent or more, they are treated as equity funds. If it is below 35 per cent, they are treated as specified mutual funds. Funds with equity exposure between 35 and 65 per cent attract 12.5 per cent tax on long-term gains and slab rates on short-term gains.
Gold ETFs, international funds and most fund of funds with less than 65 per cent Indian equity exposure follow similar rules, with long-term gains taxed at 12.5 per cent and short-term gains at slab rates.
REITs and InvITs
Listed REIT and InvIT units are taxed broadly like listed equity instruments. Gains after 12 months are taxed at 12.5 per cent above Rs 1.25 lakh, while gains within 12 months are taxed at 20 per cent.
Dividends from mutual funds are added to total income and taxed at slab rates. Non-residents and domestic companies are subject to separate provisions, with treaty benefits available in certain cases. “While REITs and InvITs are classified as business trusts and not mutual funds, their capital gains taxation broadly aligns with listed equity instruments”, Gandhi added.
