How Mutual Fund Taxation Works: The Basics

Capital gains on mutual funds in India depend on three things: the type of fund, how long you hold it, and whether it qualifies as "equity-oriented." These rules were significantly reshaped by the Finance (No. 2) Act, 2024 (effective July 23, 2024), and confirmed unchanged by Budget 2026 for FY 2026-27 (AY 2027-28).

Equity Mutual Funds

Funds with more than 65% domestic equity exposure qualify as equity-oriented for tax purposes.

• The ₹1.25 lakh annual exemption applies to your combined LTCG from equity mutual funds and listed shares put together — not separately for each.
• No indexation benefit is available on equity fund LTCG (this was never available even before the 2024 changes).
• This bracket also covers ELSS (tax-saving) funds once their mandatory 3-year lock-in ends.

Debt Mutual Funds

This is the category most investors get wrong. Since the Finance Act 2023, debt mutual funds (and other "specified mutual funds" under Section 50AA) have no long-term capital gains benefit at all for units purchased on or after April 1, 2023.

• No indexation benefit, regardless of how long you hold the units.
• From FY 2025-26, the definition of "specified mutual fund" under Section 50AA was narrowed slightly — it now applies to funds investing more than 65% of proceeds in debt/money market instruments (previously the threshold was different).
• Debt funds purchased before April 1, 2023 may still follow the older tax treatment for that specific holding — a detail worth checking with your fund statement or CA if you hold legacy units.

Hybrid Funds

Taxation depends on the fund's actual equity allocation:

Always check the fund's actual portfolio allocation (available in the factsheet) rather than assuming based on the fund's name.

Gold Funds, International Funds & Gold ETFs

These categories — along with any fund holding 35% or less in domestic equity — fall under the "specified mutual fund" rules for units bought on or after April 1, 2023:

• Held over 24 months: Taxed at 12.5% as long-term gains, but without the ₹1.25 lakh exemption (that exemption applies only to equity-oriented funds under Section 112A).
• Held under 24 months: Taxed at slab rate as short-term gains.

Quick Reference Table

SIP Taxation: How Holding Period Is Calculated

Each SIP installment is treated as a separate investment with its own purchase date. When you redeem, gains are computed using the FIFO (First-In-First-Out) method — meaning your oldest units are considered sold first. This matters because a single redemption from a long-running SIP could include a mix of both short-term and long-term units, each taxed differently.

Set-Off and Carry-Forward of Losses

• Short-term capital losses can be set off against both short-term and long-term capital gains.
• Long-term capital losses can only be set off against long-term capital gains.
• Unused losses can be carried forward for up to 8 assessment years, provided the loss is reported in a return filed on time.

A Worked Example

Suppose you invested ₹5,00,000 in an equity mutual fund and sold it after 14 months for ₹6,50,000:

• Gain: ₹1,50,000
• Since held over 12 months, this is a long-term gain
• Annual exemption: ₹1,25,000
• Taxable LTCG: ₹25,000
• Tax at 12.5%: ₹3,125 (before cess)

If the same investment were sold after 10 months instead, the entire ₹1,50,000 gain would be short-term, taxed at 20% — working out to ₹30,000, a significantly higher outgo for holding just two months less.