"Mutual fund taxation" used to mean roughly two categories: equity and debt, each with its own holding period and rate. The 2023 and 2024 reforms changed that significantly — debt funds lost indexation entirely, and hybrid funds are now taxed based on their actual portfolio composition, not their name. Here's how each category is taxed today.
| Fund Type | Holding Period for LTCG | Short-Term Rate | Long-Term Rate | Indexation |
|---|---|---|---|---|
| Equity funds (≥65% domestic equity) | > 12 months | 20% (Sec 111A) | 12.5% above ₹1.25L/yr (Sec 112A) | No |
| Debt funds & specified MFs (<35% domestic equity, acquired on/after 1 Apr 2023) | N/A — always short-term | Slab rate | Slab rate | No |
| Hybrid/balanced funds (≥65% domestic equity) | > 12 months | 20% | 12.5% above ₹1.25L/yr | No |
| Hybrid/balanced funds (<35% domestic equity) | N/A — always short-term | Slab rate | Slab rate | No |
| Funds with 35-65% domestic equity (e.g., some FoFs, gold/international FoFs) | > 24 months | Slab rate | 12.5% (no indexation) | No |
For funds that maintain at least 65% of their portfolio in domestic equity shares (as disclosed in their portfolio fact sheets), the familiar Section 111A/112A rules apply: units sold within 12 months attract 20% short-term capital gains tax, while units held beyond 12 months qualify for long-term treatment — 12.5% on gains exceeding ₹1.25 lakh in a financial year (the first ₹1.25 lakh of LTCG across all eligible equity instruments is exempt each year).
Before April 2023, debt mutual funds held for more than 3 years benefited from indexation — adjusting the purchase cost for inflation before computing the gain, which often reduced the effective tax rate well below the slab rate. The Finance Act 2023 removed this entirely for units of debt-oriented mutual funds (and other "specified mutual funds" with less than 35% domestic equity allocation) acquired on or after 1 April 2023.
For such units, regardless of how long you hold them, the entire gain is treated as short-term capital gains and added to your total income, taxed at your applicable slab rate. This made debt funds considerably less tax-efficient compared to instruments like PPF for risk-averse, high-bracket investors.
"Hybrid", "balanced advantage", "dynamic asset allocation" and similarly-named funds don't have a fixed tax treatment — their taxation follows their actual average domestic equity allocation over the holding period, as reported in the scheme's portfolio disclosures:
For "balanced advantage" or "dynamic asset allocation" funds whose equity exposure fluctuates with market valuations (sometimes dropping below 65% during expensive markets), this can mean the tax treatment of the same fund effectively shifts over time — always check the fund's current equity allocation disclosure before assuming a tax category.
Dividend (now called Income Distribution cum Capital Withdrawal, or IDCW) payouts from any mutual fund — equity, debt, or hybrid — are taxed as "Income from Other Sources" at your applicable slab rate, with TDS typically deducted at 10% if the payout exceeds the prescribed threshold in a financial year. This is separate from, and in addition to, the capital gains treatment on the units themselves.