NISM-Series-V-A: Mutual Fund Distributors · Legal and Regulatory Framework

Taxation Basics and Related Legislation for Mutual Funds

Updated 11 October 2026 · Fact-checked

Mutual fund taxation means tax on what an investor earns: capital gains on redemption and income distribution (IDCW). Tax depends on fund type (equity-oriented or debt) and holding period. TDS applies to IDCW and to NRI redemptions. Related laws include the Indian Trusts Act, the Companies Act and the Registration Act. Match fund type, period and investor status to the rule.

Understand Taxation Basics and Related Legislation for Mutual Funds

A mutual fund investor can earn in two ways: by selling units at a higher NAV (a capital gain) or by receiving IDCW (income distribution cum capital withdrawal, earlier called dividend). Each is taxed in the investor's hands. The fund itself is a pass-through: income of the scheme is generally not taxed in the scheme.

Capital gains tax depends on two things: the type of fund and the holding period. An equity-oriented fund invests at least 65% of its assets in equity shares of domestic companies. Units held for more than 12 months give long-term gains. Units held for 12 months or less give short-term gains. Debt funds are treated differently, as shown below.

For debt-oriented funds that fall in the 'specified mutual fund' category, gains are taxed at the investor's slab rate whatever the holding period. The definition has been amended over time (earlier it was linked to equity of 35% or less, later to more than 65% in debt and money market instruments). Always follow the version in your current NISM workbook. Other funds, such as gold or international funds, follow their own holding-period rules.

TDS (tax deducted at source) is a way of collecting tax early. A resident investor has TDS on IDCW above a threshold, but no TDS on capital gains. For an NRI, the fund deducts TDS on capital gains at the rates in force, and on IDCW at a flat rate. Securities Transaction Tax (STT) is charged when units of an equity-oriented fund are redeemed. Stamp duty is charged on unit purchases.

Mutual funds also sit under other laws. In India a fund is set up as a trust under the Indian Trusts Act, 1882. The sponsor is the settlor, the trustees hold the assets for unit holders, and the trust deed is registered under the Registration Act, 1908. The AMC is a company under the Companies Act, 2013. Stamp duty comes from the Indian Stamp Act. SEBI's regulations sit on top of all of these.

Key formulas to remember

Equity-oriented fund test: Equity shares of domestic companies ≥ 65% of assets; Meets this test, and it is taxed as an equity-oriented fund.
Equity fund STCG: Holding ≤ 12 months: 20%; Rate applies to gains on redemption (plus surcharge and cess where applicable).
Equity fund LTCG: Holding > 12 months: 12.5% on gains above ₹1,25,000 in a financial year; No indexation. The ₹1,25,000 exemption applies to total LTCG on such assets in the year, not per fund.
Specified mutual fund (debt-oriented): Gains taxed at slab rate, any holding period; Applies to units acquired on or after 1 April 2023. Check the current definition in your workbook.
Other funds (not equity-oriented, not specified): Short term: slab rate. Long term (listed units held > 12 months, unlisted > 24 months): 12.5%, no indexation; Holding periods depend on whether units are listed.
IDCW taxation: Taxed at investor's slab rate as income from other sources; The fund does not pay tax on it.
TDS on IDCW to residents: 10% if IDCW in the financial year exceeds the threshold (₹10,000 from FY 2025-26; ₹5,000 earlier); Once the threshold is crossed, TDS is on the whole amount.
NRI TDS: Capital gains: TDS at rates in force on the gain. IDCW: 20% plus surcharge and cess; Resident investors have no TDS on capital gains.
STT on equity-oriented fund redemption: 0.001% of the redemption value; Paid by the seller. No STT on debt fund redemption.
Set-off of losses: Short-term loss: against short-term or long-term gain. Long-term loss: only against long-term gain. Carry forward: 8 years; Losses can be carried forward only if the return is filed on time.

How to solve Taxation Basics and Related Legislation for Mutual Funds questions

Use the same sequence for any tax question. It stops you mixing up rates and investor types.

1Read the question for the investor type: resident or NRI.
2Identify the fund type: equity-oriented (65% or more domestic equity), specified debt fund, or other.
3Identify the income: capital gain on redemption or IDCW.
4For a capital gain, compute the holding period and classify it as short-term or long-term for that fund type.
5Pick the rate: 20% or 12.5% for equity, slab rate for specified debt funds, and so on.
6For equity LTCG, deduct the ₹1,25,000 exemption first, then apply the rate.
7Check TDS and STT: who deducts, at what rate, and on what base.
8For law questions, link the entity to its Act: trust to Indian Trusts Act, AMC to Companies Act.

Quickest way: Three-flag shortcut

When to use it: For MCQs asking which tax or rate applies, where you have under a minute.

Flag 1, fund: equity-oriented or debt.
Flag 2, time: 12 months or less versus more than 12 months.
Flag 3, person: resident or NRI.
Eliminate options that give a debt fund an equity rate, or a resident investor TDS on capital gains.
For law questions, remember: trust is Trusts Act, company is Companies Act, trust deed is registered.

Common mistakes in Taxation Basics and Related Legislation for Mutual Funds

Applying the 12-month rule to every fund.
Equity rules are learned first and used everywhere.
Fix: Check first whether the fund is equity-oriented, specified debt, or other. Only then look at the holding period.
Taxing the whole equity LTCG at 12.5%.
The ₹1,25,000 exemption is overlooked.
Fix: Deduct ₹1,25,000 from the year's total LTCG first, then apply 12.5% to the balance.
Saying IDCW is tax-free for the investor.
Old rules taxed dividend at the fund level (dividend distribution tax).
Fix: IDCW is now taxed in the investor's hands at slab rate. The fund does not pay tax on it.
Charging TDS on capital gains for resident investors.
NRI rules are confused with resident rules.
Fix: Resident investors have no TDS on capital gains. NRIs do, at rates in force.
Applying TDS on IDCW only to the amount above the threshold.
Mixing it up with an income tax exemption limit.
Fix: Once IDCW exceeds the threshold, TDS applies to the entire IDCW.
Treating a mutual fund as a company under the Companies Act.
The AMC is a company, so the fund is assumed to be one.
Fix: The fund is a trust under the Indian Trusts Act. Only the AMC (and often the sponsor) is a company.

Worked examples

Example 1

A resident invests ₹2,00,000 in an equity-oriented fund and redeems after 18 months for ₹3,50,000. She has no other capital gains that year. Compute the tax on the gain at 12.5% LTCG, ignoring surcharge and cess.

Show the solution

Fund is equity-oriented and holding is 18 months, which is more than 12 months, so the gain is long-term.
Gain = ₹3,50,000 − ₹2,00,000 = ₹1,50,000.
Exemption on LTCG = ₹1,25,000. Taxable gain = ₹1,50,000 − ₹1,25,000 = ₹25,000.
Tax = 12.5% × ₹25,000 = ₹3,125.
No TDS applies because she is a resident.

Answer: Tax payable is ₹3,125 (before surcharge and cess), with no TDS.

Example 2

A resident individual receives IDCW of ₹18,000 in a financial year from one mutual fund. The applicable TDS threshold is ₹10,000 and TDS rate is 10%. What TDS is deducted, and how is the IDCW taxed?

Show the solution

IDCW of ₹18,000 is more than ₹10,000, so TDS applies.
TDS applies on the whole IDCW, not only the excess.
TDS = 10% × ₹18,000 = ₹1,800.
The IDCW is also taxed in the investor's hands at slab rate. The TDS is credited against that final tax.

Answer: TDS is ₹1,800. The ₹18,000 is taxed at the investor's slab rate, with credit for the TDS.

Exam tips

Questions usually test one rule at a time: a rate, a holding period, a TDS threshold or an Act name. Learn these as exact facts.
Expect trap options that give a debt fund the equity holding period, or give NRIs and residents the same TDS treatment.
Check whether the question mentions the investor's residential status. It changes the TDS answer.
Tax rates and thresholds change in the Union Budget. Use the figures from your current NISM workbook if they differ from your notes.
Link entities to laws: trust to Indian Trusts Act 1882, AMC to Companies Act 2013, trust deed to the Registration Act.

Practice questions from Legal and Regulatory Framework

Taxation Basics and Related Legislation for Mutual Funds in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

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Taxation Basics and Related Legislation for Mutual Funds: frequently asked questions

How are equity mutual funds taxed on redemption?

If held for 12 months or less, gains are short-term and taxed at 20%. If held for more than 12 months, gains are long-term, and gains above ₹1,25,000 in a financial year are taxed at 12.5% with no indexation.

Is TDS deducted on mutual fund redemption for NRIs?

Yes. For an NRI, TDS is deducted on capital gains at the rates in force. Resident investors do not have TDS on capital gains. NRIs also face a higher flat TDS rate on IDCW.

How is IDCW from a mutual fund taxed?

IDCW is added to the investor's income and taxed at the slab rate. A resident has TDS of 10% if IDCW from a fund exceeds the threshold in a financial year.

How does the Indian Trusts Act relate to mutual funds?

In India a mutual fund is set up as a trust under the Indian Trusts Act, 1882. The sponsor is the settlor, and the trustees hold the fund assets for the benefit of unit holders. The AMC, which manages the schemes, is a company under the Companies Act, 2013.