You’ve Checked the Returns - But Have You Checked the Taxes? (Part 1 - The Basics)

Why Ignoring Taxes Can Be Expensive?

Taxes are boring and sometimes confusing! But overlooking them, or misinterpreting how they apply, can lead to sub-optimal investment decisions and portfolio allocations.

Some examples of how knowledge of tax implications can help make better investment decisions:

• When mutual fund investing is goal-based (for example, set aside for marriage, buying a house, or funding education), unexpected tax outflow at redemption can reduce the final corpus. Knowing the likely tax impact helps investors plan better and even avail certain tax exemptions

• Understanding when and how taxation applies can influence the choice between payout options like Income Distribution cum Capital Withdrawal (IDCW) and Growth.

• Applying strategies such as tax-loss or tax-gain harvesting can help optimize portfolios within regulatory limits

• Evaluating post-tax returns provides a more realistic comparison between mutual funds and other investment products

In this series, we will cover the taxation aspects of investing, starting with the basics of taxation on mutual fund Income.

De-mystifying the Taxation of Mutual Fund Income

1. Taxation at redemption:

When you redeem (or ‘sell’, in common parlance) your mutual fund units, the profits are charged under ‘Capital Gains’. Calculating how much tax you owe depends on several factors - such as the type of mutual fund, how long you’ve held it, and your applicable tax slab. Let’s break this down step by step:

Step 1: Identify the type of mutual fund - Mutual funds can be equity-oriented (where >65% of their investments are in Indian equity), debt-oriented (where >65% of their investments are in debt and money market instruments), hybrid (a mix of debt and equity allocation) and other categories (gold fund, funds investing offshore and so on). You can easily find the fund category in the scheme document or on most mutual fund platforms (like Creso)

Step 2: Calculate the Holding Period – The holding period is simply the time between the date of purchase and the date of redemption. Based on this period, your capital gains will be classified as either Short-Term Capital Gains (STCG) or Long-Term Capital Gains (LTCG).

Step 3: Determine the tax rate - The type of mutual fund and holding period will determine the tax rate for your gains. Each category has its own tax treatment, which we’ll summarize in the table below.

Step 4: Check if any exemptions are applicable – Some capital gains may be partially or fully exempt from tax. For instance, LTCG on equity-oriented mutual funds up to ₹1.25 lakh per year is exempt, subject to conditions. Always review if your gains qualify for any exemption before computing your final liability.

Still confused? We got you covered - check the table below for a quick summary of tax rates across different mutual fund categories.

* an Equity Fund of Funds is defined as a fund of funds which invests 90% of its money in the underlying funds and the underlying funds invest 90% of their money in Indian domestic equities. If not, it will be classified under ‘other funds’

** While tax on long term capital gains up to INR 1.25lakhs is exempt, it is still included in the income for determining your tax slabs (this becomes crucial especially if the investor’s income is on the verge of crossing the limit for surcharge). Exemption can also be claimed under section 54F on capital gains from sale of mutual funds, if the proceeds are used to buy a house (subject to various conditions). Please consult your tax advisor before decision making

*** 35% to 65% holdings in Indian equities based on our interpretation of the various tax sections (including Section 50AA). Alternate interpretations are possible – please consult with your tax advisor.

2. Taxation on distributions:

Distributions/dividends from mutual funds (under the IDCW – Income Distribution cum Capital Withdrawal payout option) are taxable under ‘Income from Other Sources’ at the investor’s slab rates in the year of distribution.

Importantly, even if dividends are re-invested under the IDCW option (instead of being paid out), they are still taxable in the year they are declared or re-invested.

Under the ‘Growth’ payout option, no distributions are made during the holding period, so there is no tax incidence until redemption.

Note: Please note that the tax provisions mentioned above are based on the prevailing law as of November 2025 for resident Indians and assumes the investments will be sold after 1 April 2025. Tax provisions are open to interpretation so please consult your tax advisor before any decision making.