Mutual Fund Taxation in India: Everything You Need to Know in 2025

The 2025 Union Budget brought several updates to the taxation of mutual funds under the Income Tax Act. These changes are particularly relevant for investors who hold diversified portfolios across equity, debt, hybrid, international, and other fund categories. This article simplifies the updated tax treatment of mutual fund investments, helping you navigate the current regulatory landscape more effectively.

Understanding Capital Gains and Holding Period

The taxation of mutual funds in India primarily hinges on:

• The type of mutual fund (Equity, Debt, Hybrid, International, Gold, FOFs)
• The holding period (Short-Term Capital Gains – STCG, or Long-Term Capital Gains – LTCG)
• The investor’s income bracket (especially under the new tax regime)

Capital gains are profits earned from selling mutual fund units at a price higher than the purchase cost. Depending on the holding period and type of fund, these gains are classified as either STCG or LTCG and taxed accordingly.

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1. Equity Mutual Funds (Including ELSS)

To qualify as an equity mutual fund, the portfolio must have at least 65% exposure to domestic equities.

• STCG (Holding period < 12 months): Taxed at a flat 20% with no indexation or exemption. Additionally, STT (Securities Transaction Tax) of 0.001% applies.
• LTCG (Holding period ≥ 12 months): Taxed at 12.5% on gains exceeding Rs. 1.25 lakh per annum, under Section 112A. No indexation benefit is allowed. However, the Rs. 1.25 lakh exemption offers some relief. This taxation also applies to ELSS (Equity Linked Savings Schemes), which have a mandatory 3-year lock-in period.

2. Debt Mutual Funds

Funds with <35% equity exposure fall into this category.

For Investments Before April 1, 2023:

• STCG (< 36 months): Taxed as per slab rate, no indexation.
• LTCG (≥ 36 months): Taxed at 20% with indexation (up to July 23, 2024), and 12.5% without indexation thereafter. The 2025 Budget provides a Rs. 4 lakh LTCG exemption annually for such funds. No TDS is applicable for resident investors.

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For Investments After April 1, 2023:

All gains, regardless of the holding period, are treated as STCG and taxed at slab rates. However, the Section 87A rebate (Rs. 60,000 if total income is ≤ Rs. 12.1 lakh) and the Rs. 4 lakh LTCG exemption apply, significantly easing the tax burden for middle-income investors.

Notably, indexation benefits have been removed for debt fund investments made post-April 1, 2023, reducing their tax efficiency.

3. Aggressive Hybrid Funds

These funds have >65% equity exposure and are treated like equity funds.

• STCG (< 12 months): Taxed at 20%, no indexation.
• LTCG (≥ 12 months): Taxed at 12.5% on gains above Rs. 1.25 lakh. Exemption and no indexation rules apply similar to pure equity funds.

4. Conservative Hybrid Funds

These have <35% equity exposure and are now taxed identically to debt funds for investments made post-April 1, 2023.

• Gains are taxed as STCG at slab rates, regardless of the holding period.
• Section 87A rebate and LTCG exemption of Rs. 4 lakh may apply.
• These funds no longer enjoy indexation or favorable LTCG treatment, making them less attractive for long-term investments.

5. Balanced Hybrid Funds (35%-65% Equity)

Balanced funds fall in between the tax treatment for equity and debt funds.

• Before April 1, 2023:
• <24 months: STCG at slab rate.
• ≥24 months: LTCG at 12.5%, no indexation, but Rs. 4L exemption available.
• After April 1, 2023: All gains are taxed as STCG at slab rates, and investors can only rely on standard rebates (Sec 87A). No LTCG benefit applies.

6. Gold Funds, International Funds, and Fund of Funds (FOFs)

These are grouped due to similar taxation treatment and <35% equity exposure.

• Investments Before April 1, 2023:
• <36 months: STCG at slab rates.
• ≥36 months: LTCG taxed at 20% with indexation till July 2024, then 12.5%. Rs. 4 lakh exemption applies.
• Investments After April 1, 2023:
• <24 months: STCG at slab rate.
• ≥24 months: LTCG at 12.5%, with Rs. 4 lakh exemption, no indexation.

7. Dividends (All Fund Categories)

Since the removal of Dividend Distribution Tax (DDT) in 2020, all dividends are taxed as per investor’s slab rate.

• TDS of 10% for residents, 20% for NRIs is deducted.
• Investors pay tax on dividends received post-budget, adding to taxable income.

8. Systematic Withdrawal Plans (SWPs)

SWP withdrawals are taxed based on the type of capital gain, the fund category, and holding period.

• Tax treatment depends on whether the withdrawals constitute STCG or LTCG.
• Section 87A and LTCG exemptions apply if criteria are met.

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9. Taxation for Non-Resident Indians (NRIs)

• Taxed based on DTAA (Double Taxation Avoidance Agreement) terms between India and the resident country.
• TDS is generally 20% for equity STCG. Other rates depend on the agreement.
• NRIs must check specific DTAA provisions to claim lower tax or exemption and avoid double taxation.

10. Bonus Stripping Rules

Applicable when units are bought and sold around bonus declarations.

• If units are sold within 3 months of purchase and bonus units bought 9 months before or after, capital loss is disallowed.
• Only cost of bonus units is considered, as per Section 94(8) of the Income Tax Act.

Key Budget 2025 Introductions

• Section 87A Rebate: Raised to Rs. 60,000 for individuals with income up to Rs. 12.1 lakh.
• Rs. 4 Lakh LTCG Exemption: Applies across most fund categories that were previously taxed at the slab rate.
• Removal of Indexation: Major change for debt and gold funds post-July 2024.
• LTCG Treatment Removed: For debt-like instruments post-April 2023, pushing investors to reconsider asset allocation.

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