Income Tax: Just like any financial asset, the sale of mutual funds also attracts capital gains tax. How much capital gains tax is levied hinges on two key factors: whether it is equity or debt mutual fund, and how long is the holding period (i.e., whether it is short term or long term gain).
Different rules apply on it. Here we deconstruct the capital gain rules based on the category of mutual funds. The rate of capital gains tax is high (20%) when the tenor is short and the rate is low (12.5%) in case of long tenor.
Capital gains tax on equity mutual funds
Equity mutual funds refer to those funds which have 65 percent or higher allocation of assets to equity. If you sell the units of equity mutual funds within one year of purchase, gains accured on the sale are taxable at the rate of 20%, whereas the sale after one year of purchase attracts a tax at the rate of 12.5% on gains above ₹1.25 lakh in one financial year.
“For equity‑oriented funds, short‑term gains (held for less than 12 months) are taxed at 20% and long‑term gains (held for longer than 12 months) are taxed at 12.5% above the ₹1.25 lakh exemption,” says Shefali Mundra, Tax Expert at ClearTax.
Capital gains tax on debt mutual funds
A debt mutual fund (also known as income fund) refers to the scheme that invests primarily in bonds or other debt securities. Debt funds invest in short and long-term securities issued by government, public financial institutions and companies, per the Sebi’s categorisation of mutual fund schemes.
Debt mutual funds are referred to as ‘specified mutual funds’ for taxation purposes. Under Section 50AA of the Income-tax Act, specified mutual fund is defined as a mutual fund scheme where not more than 35% of its total proceeds are invested in the equity shares of domestic companies.
The rate of tax on the sale of debt mutual funds is dependent on the date of sale.
“On the funds bought before 1 April 2023, tax on the sale is levied at the rate of 12.5% when the units are sold two years after purchase. Short term gain (sold in less than 2 years of purchase) is taxed as per normal slab,” says chartered accountant Pratibha Goyal, partner, PD Gupta & Company.
Meanwhile, the sale of debt mutual funds purchased on or after 1 April 2023 are taxed as per the slab rate irrespective of holding period, adds CA Goyal.
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