Taxation of equity mutual funds in India

Taxation of equity mutual funds in India is governed principally by Sections 111A and 112A of the Income Tax Act 1961, with rates last revised by the Finance Act 2024 with effect from 23 July 2024. An equity-oriented mutual fund, as defined under Section 112A(10), is a fund that invests at least 65% of its total proceeds in equity shares of domestic companies. Capital gains on such funds are split into short-term capital gains (STCG) if the units are held for twelve months or less, and long-term capital gains (LTCG) if held for more than twelve months. As of 23 July 2024, STCG is taxed at 20% under Section 111A and LTCG exceeding Rs 1,25,000 per financial year is taxed at 12.5% under Section 112A, without the benefit of indexation. Dividend income distributed by equity funds, renamed Income Distribution cum Capital Withdrawal (IDCW) by SEBI in 2021, is taxed as ordinary income at slab rates.

Tax advice disclaimer. This article is for educational reference only and does not constitute professional tax or financial advice. Tax law changes frequently and individual circumstances vary widely. Readers should consult a qualified Chartered Accountant or tax adviser before making any investment or tax-filing decision.

Definition of equity-oriented fund

Under Section 112A(10) of the Income Tax Act 1961, a fund qualifies as equity-oriented if:

1. More than 65% of its total proceeds are invested in equity shares of companies listed on a recognised stock exchange in India; and
2. The fund is a Mutual Fund registered under the SEBI (Mutual Funds) Regulations 1996.

The 65% threshold is tested as a quarterly average of the daily net assets during the financial year. SEBI’s fund categorisation circular (October 2017) aligns fund categories with this definition. Large-cap funds, mid-cap funds, small-cap funds, multi-cap funds, flexi-cap funds, focused equity funds, value and contra funds, sector funds, thematic funds, and ELSS all qualify as equity-oriented.

Arbitrage funds, though structured to exploit price differentials between cash and futures markets, are classified as equity-oriented because they maintain at least 65% of assets in equity (with corresponding short futures hedges). Their taxation is covered separately in the arbitrage fund taxation article.

Balanced advantage funds (dynamic asset allocation funds) and aggressive hybrid funds may or may not meet the 65% threshold depending on their actual equity allocation and are treated under hybrid mutual fund taxation.

Short-term capital gains (STCG)

Holding period

A unit of an equity-oriented mutual fund is treated as a short-term capital asset if it has been held for not more than twelve months immediately before the date of transfer. The date of allotment is the start date; the date of redemption (or switch-out, treated as a deemed sale) is the end date. In a Systematic Investment Plan (SIP), each instalment is a separate lot with its own acquisition date. The FIFO method under the SIP taxation article explains how holding periods are assigned when only some units in a series are redeemed.

Rate and charging section

Section 111A applies to STCG on equity-oriented mutual funds where Securities Transaction Tax (STT) has been paid at the time of redemption. The Finance Act 2024 raised the rate from 15% to 20%, effective 23 July 2024. Prior to that date, the 15% rate continues to apply. The STCG is taxed at 20% regardless of the investor’s income-tax slab.

Where STT has not been paid (for example, on off-market transfers or units acquired before the introduction of STT), the gain is not eligible for the concessional Section 111A rate and is instead added to total income and taxed at the applicable slab rate.

Surcharge and cess

The 20% rate is subject to:

• Surcharge: 10% for income between Rs 50 lakh and Rs 1 crore; 15% for income between Rs 1 crore and Rs 2 crore; 25% for income between Rs 2 crore and Rs 5 crore (capped at 15% for Section 111A income under Finance Act 2023 provisions); 37% otherwise capped at 15% for Section 111A income.
• Health and Education Cess: 4% on tax plus surcharge.

The effective maximum rate on Section 111A gains for individuals therefore does not exceed approximately 23.92% (20% + 15% surcharge + 4% cess).

Deduction of basic exemption

For resident individuals and Hindu Undivided Families (HUFs) whose total income other than STCG under Section 111A is below the basic exemption limit, the shortfall can be set off against such STCG, effectively reducing the taxable base.

Long-term capital gains (LTCG)

Holding period

An equity-oriented mutual fund unit is treated as a long-term capital asset if it has been held for more than twelve months. The Finance Act 2018 changed the threshold for equity from the earlier 36-month rule to 12 months (effective 1 April 2018), consistent with listed equity shares.

Rate and charging section

Section 112A applies to LTCG on equity-oriented mutual funds where STT was paid on both acquisition and redemption. The Finance Act 2024 changed the rate from 10% to 12.5%, effective 23 July 2024, and simultaneously raised the annual exemption threshold from Rs 1,00,000 to Rs 1,25,000. Gains up to Rs 1,25,000 per financial year remain fully exempt; gains above this threshold are taxed at 12.5% without indexation benefit.

The pre-Finance Act 2024 rate of 10% applies to redemptions made on or before 22 July 2024; the 12.5% rate applies to redemptions made on or after 23 July 2024.

Indexation

Section 112A explicitly excludes the benefit of indexation under the second proviso to Section 48. This means the cost of acquisition is not adjusted for inflation when computing LTCG on equity-oriented mutual funds, unlike debt mutual funds before April 2023 or immovable property.

Grandfathering

For equity-oriented mutual fund units acquired before 1 February 2018 and redeemed after 31 March 2018, the grandfathering provision in Section 55(2)(ac) applies. The cost of acquisition is deemed to be the higher of:

• The actual purchase price; and
• The lower of the fair market value (FMV) as on 31 January 2018 and the actual sale price.

This mechanism ensures that all appreciation occurring before 1 February 2018 is excluded from the taxable base. The grandfathering mechanism was not altered by the Finance Act 2024. Detailed computation methodology is discussed in the grandfathering rule for LTCG article.

Intra-year threshold aggregation

The Rs 1,25,000 exemption is an annual aggregate across all Section 112A transactions in a financial year, covering both listed equity shares and equity-oriented mutual fund units. Investors with multiple redemptions must pool all LTCG to determine what fraction exceeds the threshold.

Equity-Linked Savings Scheme (ELSS)

ELSS funds are equity-oriented funds with a statutory three-year lock-in. Investments of up to Rs 1,50,000 per financial year qualify for deduction under Section 80C of the Income Tax Act 1961. Upon redemption at the end of (or after) the lock-in, the gain always qualifies as LTCG under Section 112A because the three-year holding period vastly exceeds the twelve-month LTCG threshold. The Rs 1,25,000 annual exemption applies to ELSS redemption gains in the same way as to any other equity-oriented fund.

IDCW (dividend) income

SEBI’s circular SEBI/HO/IMD/DF3/CIR/P/2020/194 (October 2020), effective April 2021, renamed the dividend option of mutual funds to Income Distribution cum Capital Withdrawal (IDCW). Regardless of the label change, tax treatment follows Section 2(22) read with Section 56(2)(i): IDCW distributed by any mutual fund is included in the investor’s total income and taxed at the applicable income-tax slab rate.

TDS is deducted on IDCW payments:

• For resident investors: 10% TDS under Section 194K if the aggregate IDCW in a financial year exceeds Rs 5,000.
• For NRI investors: 20% TDS (plus surcharge and cess) under Section 195, subject to DTAA relief where applicable.

IDCW reduces the Net Asset Value (NAV) of the fund by the distribution amount on the ex-dividend date. Switching the dividend option to growth option or vice versa triggers a redemption and fresh purchase, attracting capital gains tax. This is treated as an MF switch as a taxable event.

Set-off and carry-forward

Short-term capital losses on equity-oriented funds can be set off against both STCG and LTCG in the same year. Long-term capital losses can only be set off against LTCG. Unabsorbed capital losses (short-term or long-term) can be carried forward for eight assessment years but only against capital gains of the respective type. Carry-forward requires the return of income to be filed on or before the due date under Section 139(1).

Dividend stripping under Section 94(7) and bonus stripping under Section 94(8) impose special disallowance rules that restrict the set-off of artificially manufactured capital losses generated around ex-dividend or ex-bonus dates.

Switch transactions

A switch from one equity fund to another (or from the regular plan to the direct plan of the same fund) is treated as a redemption of the source fund and a fresh purchase in the destination fund under Section 2(47). Capital gains (or losses) crystallise at the switch date based on the switching NAV, and the holding period for the new units resets to zero. STP (Systematic Transfer Plan) transactions are governed by the same rule, with each transfer instalment treated as a partial redemption.

Tax deducted at source

For resident investors, no TDS applies on capital gains from mutual fund redemptions. Section 194K, introduced by the Finance Act 2020, levied TDS on mutual fund units but was subsequently clarified by the CBDT to apply only to IDCW payments (dividends), not to capital gains redemptions. The clarification is contained in the CBDT Press Release dated 4 February 2020.

For NRI investors, TDS applies to all redemption proceeds under Section 195 at 30% on STCG and 12.5% on LTCG (post-23 July 2024 rates), gross of the Rs 1,25,000 exemption. The exemption threshold is claimable only at the time of filing the return of income. This is covered in detail in TDS on MF redemption for NRIs.

Reporting in income-tax returns

Capital gains from equity mutual funds are reported in Schedule CG of ITR-2 (for individuals with no business income) or ITR-3 (for individuals with business income). LTCG exempt under the Rs 1,25,000 threshold still needs to be reported. The amounts should match data visible in the Annual Information Statement (AIS) and the Tax Information Summary (TIS), which capture mutual fund transactions reported by fund houses under the Statement of Financial Transactions (SFT) framework.

Taxpayers using the AIS/TIS mapping methodology should reconcile IDCW income, STCG, and LTCG figures against the AIS before filing to avoid discrepancy notices from the tax department.

Impact of the Finance Act 2024

The Finance Act 2024 (effective 23 July 2024) made the following changes relevant to equity mutual funds:

The Finance Act 2024 also rationalised the holding-period thresholds and taxation of several other asset classes but did not alter the 12-month holding period for equity-oriented mutual funds.

Historical rate table

See also

• Section 111A – Short-term capital gains on equity
• Section 112A – Long-term capital gains on equity
• Grandfathering rule for LTCG
• Equity MF grandfathering (31 January 2018)
• ELSS and Section 80C deduction
• TDS on MF redemption for NRIs (Section 195)
• Arbitrage fund taxation
• Hybrid mutual fund taxation
• SIP taxation and FIFO method
• MF switch as a taxable event
• Dividend stripping disallowance (Section 94(7))
• Securities Transaction Tax
• Capital gains tax in India
• Annual Information Statement
• ITR-2

References

1. Income Tax Act 1961, Section 111A (as amended by Finance Act 2024).
2. Income Tax Act 1961, Section 112A (as amended by Finance Act 2024).
3. Income Tax Act 1961, Section 55(2)(ac) – grandfathering provision.
4. Income Tax Act 1961, Section 80C – deductions including ELSS.
5. Income Tax Act 1961, Section 194K – TDS on IDCW.
6. Finance Act 2024, clauses amending Sections 111A and 112A, effective 23 July 2024.
7. CBDT Press Release dated 4 February 2020 on clarification of Section 194K.
8. SEBI Circular SEBI/HO/IMD/DF3/CIR/P/2020/194 (October 2020) – IDCW renaming.
9. SEBI (Mutual Funds) Regulations 1996, Regulation 2 – definitions.
10. SEBI Circular on Categorisation and Rationalisation of Mutual Fund Schemes (October 2017).