NISM-Series-V-A: Mutual Fund Distributors · Taxation

Tax Treatment of Mutual Fund Schemes Themselves

Updated 11 October 2026 · Fact-checked

Mutual fund schemes are not taxed on their income at the fund level. Income of a SEBI-registered mutual fund is exempt under Section 10(23D) of the Income-tax Act, 1961. Tax is levied on the investor when gains or income are received. The fund pays costs like STT on its own trades and may bear some other levies.

Understand Tax Treatment of Mutual Fund Schemes Themselves

A mutual fund is a pass-through vehicle. It pools money from many investors, invests it, and passes returns back through NAV changes and payouts. If the fund were taxed first and the investor taxed again, the same income would be taxed twice. The law avoids this by exempting the fund.

The exemption sits in Section 10(23D) of the Income-tax Act, 1961. It exempts the income of a mutual fund registered with SEBI (or set up by a public sector bank, a public financial institution, or authorised by RBI, subject to SEBI regulations). The exemption applies to the scheme's income such as interest, dividends and capital gains earned from investments.

The exemption is about the fund's own income. It is not about what you, the investor, pay. When you redeem units you pay capital gains tax. When you receive an income distribution (IDCW) it is taxed in your hands. Keep these two levels apart in your head: fund level and investor level.

The exemption holds whether the scheme is equity, debt, hybrid or another category, provided the fund is a SEBI-registered mutual fund. What differs by category is how the investor is taxed on units, not whether the fund itself pays income tax. Equity-oriented schemes also attract Securities Transaction Tax (STT) when the fund buys or sells equity shares on an exchange, which is a transaction levy and not income tax on the fund.

Specialised vehicles need care. A fund of funds invests in units of other mutual fund schemes. The underlying schemes are exempt, and the fund of funds is a mutual fund scheme too, so it is exempt at fund level. Its investors are taxed on their units according to the rules for the category it falls in. Other pooled vehicles like Alternative Investment Funds or REITs/InvITs follow their own regimes and are not mutual funds. Do not carry the 10(23D) exemption over to them.

Key formulas to remember

Fund-level exemption: Income of SEBI-registered mutual fund → exempt under Section 10(23D); Applies to the fund's income. It does not make the investor's gains tax-free.
Two levels of tax: Fund level: no income tax on scheme income | Investor level: tax on capital gains and IDCW; Most exam traps mix these two levels.
Transaction levy on fund trades: STT applies on equity transactions on exchanges; STT is not income tax on the fund's income. It is a transaction cost of dealing in securities.
Fund of funds: Fund of funds = mutual fund scheme investing in other schemes → exempt at fund level; Investor taxation depends on the category rules for the units held.

How to solve Tax Treatment of Mutual Fund Schemes Themselves questions

Use this method for any question on how a scheme itself is taxed.

1Read the question and decide whether it asks about the fund level or the investor level.
2If it is fund level, check that the vehicle is a SEBI-registered mutual fund scheme.
3If yes, apply the Section 10(23D) exemption: no income tax on scheme income.
4Check the category word (equity, debt, hybrid, fund of funds, ETF). It changes investor taxation, not the fund's exemption.
5Look for STT or other transaction costs if the option mentions them. These are costs, not income tax on income.
6Reject options that apply the exemption to non-mutual-fund vehicles or to the investor's gains.
7Pick the option that matches both the level and the vehicle.

Quickest way: Level-and-vehicle check

When to use it: Use when the options look similar and time is short.

Ask: fund or investor?
Fund level and SEBI-registered mutual fund: answer is exempt under 10(23D).
Investor level: the answer is capital gains or IDCW tax, not this topic.
Eliminate any option saying the scheme pays tax on its income by category.

Common mistakes in Tax Treatment of Mutual Fund Schemes Themselves

Saying equity funds are exempt but debt funds are taxed at fund level.
Students confuse the different investor-level tax rates with the fund's own status.
Fix: The fund-level exemption does not depend on equity or debt. Category affects how investors are taxed.
Believing the exemption means investors pay no tax.
The word exempt is read too broadly.
Fix: Exemption covers only the fund's income. Investors pay tax on gains and IDCW.
Treating STT as income tax on the fund.
Both are called taxes.
Fix: STT is a levy on securities transactions. It does not remove the Section 10(23D) exemption.
Extending 10(23D) to AIFs, REITs or PMS.
All are pooled investments, so they seem alike.
Fix: The exemption is for SEBI-registered mutual funds. Other vehicles have separate regimes.
Thinking a fund of funds is taxed twice at fund level.
It holds other funds, so students expect a double layer.
Fix: Both the underlying scheme and the fund of funds are mutual fund schemes and exempt at fund level.

Worked examples

Example 1

Which statement about the tax position of a SEBI-registered equity mutual fund scheme on its own income is correct? (a) It pays income tax at the corporate rate (b) Its income is exempt under Section 10(23D) (c) It is exempt only on dividend income (d) It is exempt only if it distributes all income

Show the solution

The question is about the fund level, not the investor.
The scheme is a SEBI-registered mutual fund, so Section 10(23D) applies.
The exemption covers the scheme's income, not only dividends, and has no distribution condition in the options given.
Options (a), (c) and (d) misstate the position.

Answer: (b) Its income is exempt under Section 10(23D).

Example 2

A debt fund scheme earns interest and capital gains. Which is the correct view? (a) Debt schemes are taxed at fund level, equity schemes are not (b) The scheme's income is exempt at fund level, and investors are taxed on their gains (c) The scheme is exempt but investors pay nothing (d) The scheme pays tax only on capital gains

Show the solution

Identify the level: the scheme's income, plus the investor's position.
A debt scheme that is a SEBI-registered mutual fund is covered by Section 10(23D).
Interest and capital gains of the scheme are both exempt at fund level.
Investors still pay tax when they redeem or receive IDCW.
Only (b) states both points.

Answer: (b) The scheme's income is exempt at fund level, and investors are taxed on their gains.

Exam tips

Always decide first whether the question is about the fund or the investor.
Remember the section number 10(23D) and link it to SEBI-registered mutual funds only.
Watch for options that split exemption by equity and debt. They are traps.
Treat STT as a transaction cost, not as a fund-level income tax.
For fund of funds and other specialised schemes, state that the fund is exempt and the investor tax follows the category rules.

Practice questions from Taxation

Tax Treatment of Mutual Fund Schemes Themselves: frequently asked questions

Are mutual funds exempt from tax under Section 10(23D)?

Yes. The income of a SEBI-registered mutual fund is exempt from income tax under Section 10(23D). This is the fund's own income. Investors are still taxed on their gains and IDCW.

Do equity and debt schemes pay different tax at fund level?

No. Both are exempt on scheme income as mutual funds. The difference lies in how investors are taxed on units and in STT on equity trades.

Is a fund of funds taxed at fund level?

A fund of funds is a mutual fund scheme and its income is exempt at fund level. Its investors are taxed on their units under the rules for its category.

Does the exemption apply to AIFs and REITs?

No. The 10(23D) exemption is for mutual funds. Other vehicles like AIFs and REITs follow their own tax rules.