Taxation of hybrid mutual funds in India

Taxation of hybrid mutual funds in India is determined primarily by the equity allocation of the fund, which places it into one of three tax buckets: equity-oriented (more than 65% in domestic equity), specified mutual fund (35% or less in domestic equity), or a residual intermediate category that existed briefly before the Finance Act 2023 reforms. Hybrid funds span the spectrum from aggressive hybrid funds (65-80% equity) to conservative hybrid funds (10-25% equity), and their tax treatment tracks the actual allocation rather than the category label. With the Finance Act 2023 eliminating the LTCG with indexation benefit for funds below the 65% equity threshold, and the Finance Act 2024 revising STCG and LTCG rates on equity-oriented funds, hybrid fund investors must pay particular attention to the equity allocation at the time of investment and at the time of redemption.

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.

Classification framework

Three-tier equity-allocation test

Indian tax law classifies mutual funds for capital-gains purposes based on the percentage of total proceeds invested in equity shares of domestic companies (listed or to be listed on a recognised stock exchange):

The 65% threshold determines whether a fund attracts equity-fund taxation (Section 111A for STCG and Section 112A for LTCG), and the 35% threshold introduced by the Finance Act 2023 determines whether the specified-MF slab-rate regime applies to units acquired after 1 April 2023. Funds in the intermediate band (equity 35-65%) are subject to older Section 112 treatment for units acquired before 1 April 2023 (LTCG at 20% with indexation after 36 months) and to the new slab-rate regime for units acquired on or after 1 April 2023.

The 65% test: equity-oriented status

The 65% test is applied as a quarterly average of the daily closing net asset values during the financial year. SEBI’s fund categorisation circular (October 2017, revised 2018) sets the minimum investment constraints:

• Aggressive hybrid funds: 65-80% in equity. These consistently qualify as equity-oriented and attract Section 111A/112A taxation.
• Balanced advantage funds / dynamic asset allocation funds: Equity allocation is actively managed and may range from 0-100%. When equity falls below 65% in a given period, the fund may lose equity-oriented status for that financial year.
• Equity savings funds: Minimum 65% in equity (with a portion in arbitrage). These qualify as equity-oriented.
• Multi-asset allocation funds: At least 10% each in three asset classes; equity component may or may not reach 65%.

The 35% test: specified-MF regime

Funds consistently below 35% equity:

• Conservative hybrid funds (10-25% in equity): These were previously taxed as debt-like (LTCG at 20% with indexation). Units acquired on or after 1 April 2023 are subject to the specified-MF slab-rate regime. See debt mutual fund taxation (post-April 2023).
• Arbitrage funds: Though structurally hedged, arbitrage funds maintain gross equity of 65%+ and are classified as equity-oriented. Taxation is covered in arbitrage fund taxation.

Tax treatment by category

Aggressive hybrid funds (equity-oriented)

Aggressive hybrid funds maintain equity allocation above 65% at all times as per SEBI mandate, qualifying them as equity-oriented. Taxation:

• STCG (held up to 12 months): 20% under Section 111A where STT is paid. Rate effective 23 July 2024 per Finance Act 2024 (previously 15%).
• LTCG (held more than 12 months): 12.5% under Section 112A on gains exceeding Rs 1,25,000 per financial year. No indexation. Grandfathering applies for units acquired before 1 February 2018.

Balanced advantage funds (dynamic asset allocation)

Balanced advantage funds (BAFs) present a tax complexity because their equity allocation fluctuates. AMCs typically manage the gross equity allocation (including derivatives hedges) at 65%+ to maintain equity-oriented classification. However, the tax classification is based on actual net equity allocations, not gross.

Where a BAF’s equity allocation dips below 65% during a financial year, the fund’s units may be classified as non-equity for that year. In practice, most BAF AMCs publicly maintain the 65% gross equity threshold for tax classification. Investors should check the fund house’s communication on equity allocation before assuming equity-fund taxation.

Assuming equity-oriented classification is maintained: STCG at 20% (Section 111A), LTCG at 12.5% (Section 112A), Rs 1,25,000 threshold.

Conservative hybrid funds (35% or below equity)

Conservative hybrid funds, with equity of 10-25%, are specified mutual funds under the Finance Act 2023 framework for units acquired on or after 1 April 2023. All gains from such units are treated as short-term capital gains and taxed at slab rates, irrespective of holding period. For units acquired before 1 April 2023, the old 36-month LTCG rule with indexation still applies.

Multi-asset allocation funds

Multi-asset allocation funds invest across equity, debt, and commodities (or real estate, gold, etc.). Their tax classification depends on the equity component:

• If equity exceeds 65%: equity-oriented treatment (Section 111A/112A).
• If equity is between 35% and 65%: intermediate treatment (old units: LTCG after 36 months; new units: slab rate).
• If equity is 35% or below: specified-MF treatment for new units.

Fund houses publish the applicable equity level for tax classification purposes in their Key Information Memorandum (KIM).

Equity savings funds

Equity savings funds maintain a minimum of 65% in equity (with a portion in arbitrage and some in debt). They are equity-oriented and taxed under Section 111A and 112A, identical to aggressive hybrid funds.

The intermediate category (35-65% equity)

Between 1 April 2018 and 31 March 2023, funds with equity of 35-65% occupied an awkward middle ground: they were not equity-oriented (so Sections 111A and 112A did not apply), but they were also not treated as pure debt. The LTCG regime for such funds was:

• Holding period threshold: 36 months.
• LTCG rate: 20% with indexation under Section 112.
• STCG: Slab rate.

From 1 April 2023, the Finance Act 2023 extended the specified-MF treatment to all funds where equity does not exceed 35%, effectively eliminating the 35-65% intermediate category’s tax advantage for new purchases. Funds in the 35-65% equity band for new units acquired from 1 April 2023 are now taxed at slab rates (the same as funds below 35%). The 36-month LTCG treatment with indexation continues only for units of such funds acquired before 1 April 2023.

Impact of Finance Act 2024 on hybrid funds

The Finance Act 2024 (effective 23 July 2024) changed the taxation of equity-oriented hybrid funds as follows:

Funds classified as specified MFs were unaffected by Finance Act 2024 since their gains were already taxed at slab rates.

Dividend (IDCW) income from hybrid funds

IDCW from hybrid funds is taxed identically to IDCW from pure equity or pure debt funds: included in total income and taxed at slab rates. TDS at 10% under Section 194K applies if aggregate IDCW exceeds Rs 5,000 in the financial year for resident investors. For NRI investors, Section 195 TDS applies.

Switch transactions between hybrid fund plans

Switching from the regular plan to the direct plan of a hybrid fund, or from one hybrid fund to another, constitutes a taxable event identical in structure to a redemption followed by a fresh purchase. The holding period for the destination fund’s units resets to the switch date.

Set-off and carry-forward

Capital losses from hybrid funds are set off per the normal capital gains rules:

• STCG losses from equity-oriented hybrid funds can be set off against STCG and LTCG from any capital asset.
• LTCG losses from equity-oriented hybrid funds can only be set off against LTCG.
• STCG losses from specified MFs (debt-like hybrid funds) follow the same STCG offset rules.

Carry-forward for eight assessment years is permitted, subject to timely filing.

Reporting in income-tax returns

Hybrid fund capital gains are reported in Schedule CG of ITR-2 or ITR-3. The categorisation (STCG Section 111A, STCG other, LTCG Section 112A, LTCG other) must match the fund’s actual equity classification for the relevant financial year. Reconciliation against the Annual Information Statement is advisable; the AIS/TIS mapping article explains the reconciliation process.

Planning considerations

1. Verify equity allocation before assuming equity-fund treatment. For BAFs and multi-asset funds, check the AMC’s published equity allocation data and their annual fund reclassification certificate.
2. Grandfathering applies only to equity-oriented units. Pre-2018 units of conservative or intermediate hybrid funds do not benefit from the 31 January 2018 FMV provision.
3. Switching between hybrid categories is a taxable event. Moving from a conservative hybrid fund to an aggressive hybrid fund involves a redemption and triggers capital gains.
4. SIP taxation in hybrid funds follows FIFO. Each instalment acquires a separate holding period; the SIP FIFO article explains the mechanics.

See also

• Equity mutual fund taxation in India
• Debt mutual fund taxation (post-April 2023)
• Arbitrage fund taxation
• Fund of Funds taxation (revised 2024)
• STCG on equity MFs (Section 111A)
• LTCG on equity MFs (Section 112A)
• SIP taxation and FIFO method
• MF switch as a taxable event
• MF IDCW TDS for residents
• Indexation removal for debt MFs (Finance Act 2023)
• Capital gains tax in India
• Securities Transaction Tax
• ITR-2
• Annual Information Statement

References

1. Income Tax Act 1961, Section 111A (as amended by Finance Act 2024).
2. Income Tax Act 1961, Section 112A(10) – definition of equity-oriented fund.
3. Income Tax Act 1961, Section 112 – LTCG on non-equity assets.
4. Finance Act 2023 – specified mutual fund provisions.
5. Finance Act 2024, clauses amending Section 111A and 112A rates.
6. SEBI Circular on Categorisation and Rationalisation of Mutual Fund Schemes (October 2017).
7. SEBI (Mutual Funds) Regulations 1996, Regulation 53 – investment objectives.
8. CBDT Circular on classification of equity-oriented funds.
9. Memorandum Explaining the Provisions of the Finance Bill 2023 (Ministry of Finance).
10. Memorandum Explaining the Provisions of the Finance Bill 2024 (Ministry of Finance).