NISM-Series-X-A: Investment Adviser (Level 1) · Mutual Funds

Taxation of Mutual Funds: Capital Gains and IDCW

Updated 11 October 2026

Mutual fund tax depends on the fund type and how long you hold it. Equity-oriented funds: 20% on short-term gains (up to 12 months) and 12.5% on long-term gains above ₹1,25,000 a year. Specified debt funds bought after 1 April 2023 are taxed at slab rate. IDCW is taxed at slab rate.

Understand Taxation of Mutual Funds

A mutual fund investor can earn in two ways: capital gains when units are sold, and IDCW (Income Distribution cum Capital Withdrawal) paid by the fund. Each is taxed differently. The rates below follow the rules in force after the July 2024 changes. Always check which rates your exam version uses.

First, classify the fund. An equity-oriented fund keeps at least 65% of its assets in domestic equity shares. Equity index funds, equity hybrid funds with 65% or more equity, and arbitrage funds fall here. A specified mutual fund is, broadly, a debt fund. It is a fund that invests more than 65% of its assets in debt and money market instruments. Units of a specified mutual fund bought on or after 1 April 2023 fall under Section 50AA. The Finance Act 2024 widened the coverage of Section 50AA and changed the definition of a specified mutual fund from 1 April 2025. Follow the definition given in your syllabus version. Everything else is a non-equity fund that is not specified. This includes hybrid funds with 35% to 65% equity, gold funds and international funds.

Next, look at the holding period. For equity-oriented funds, units held for 12 months or less give short-term capital gains (STCG), taxed at 20%. Units held for more than 12 months give long-term capital gains (LTCG), taxed at 12.5% on total LTCG above ₹1,25,000 in a financial year. There is no indexation.

Specified mutual funds bought on or after 1 April 2023 are different. Holding period does not matter. All gains are treated as short-term and taxed at your slab rate.

Other non-equity funds are not under Section 50AA. These include hybrids with 35% to 65% equity, gold funds and international funds. Unlisted units held for more than 24 months are long-term and taxed at 12.5% without indexation. Shorter holding means slab rate. Listed units, such as ETFs, use a 12-month test, and their LTCG is also taxed at 12.5%.

Debt fund units bought before 1 April 2023 are also outside Section 50AA. For transfers on or after 23 July 2024, they are long-term after more than 24 months, taxed at 12.5% without indexation. Otherwise the gain is taxed at slab rate.

IDCW is added to your income and taxed at your slab rate. The growth option has no tax until you redeem. A switch from one scheme to another counts as a sale, so it can trigger tax. When you sell part of a holding, units are treated as sold first-in, first-out (FIFO).

Key formulas to remember

Equity-oriented fund test: Domestic equity ≥ 65% of assets; Such funds get equity tax treatment, including equity-oriented hybrids and arbitrage funds.
Equity fund STCG: Holding ≤ 12 months → 20%; Tax is on the gain only. Surcharge and cess are extra.
Equity fund LTCG: Holding > 12 months → 12.5% on LTCG above ₹1,25,000 per financial year; No indexation. The exemption applies to total LTCG of the year, not to each fund.
Specified mutual fund (debt): Units bought on or after 1 April 2023 → gain taxed at slab rate, any holding period; Treated as short-term under Section 50AA. A specified mutual fund invests more than 65% of its assets in debt and money market instruments. The Finance Act 2024 widened Section 50AA coverage, so follow the definition in your syllabus version.
Debt fund bought before 1 April 2023: Transfer on or after 23 July 2024: holding > 24 months → LTCG at 12.5%, no indexation; otherwise slab rate; These units are outside Section 50AA.
Other non-equity funds: Unlisted units: holding > 24 months → LTCG at 12.5%, no indexation; otherwise slab rate; Applies to hybrid funds with 35% to 65% equity, gold funds, international funds and similar funds that are not specified. Listed units, such as ETFs, use 12 months, and their LTCG is also 12.5%.
Capital gain: Gain = Sale value − Purchase cost; For old equity units bought before 1 February 2018, grandfathering can raise the cost.
IDCW tax: IDCW taxed at slab rate; TDS 10% for residents above the yearly threshold; The TDS threshold is ₹10,000 from FY 2025-26 (earlier ₹5,000). Check the version tested.
Loss set-off: STCL against STCG or LTCG; LTCL only against LTCG; carry forward 8 years; Losses must be reported in a return filed on time to be carried forward.

How to solve Taxation of Mutual Funds questions

Use the same order for every tax question on mutual funds. It keeps you from mixing up the rates.

1Identify the income type: capital gain on sale or switch, or IDCW.
2Classify the fund: equity-oriented (65% or more equity), specified debt fund, or other non-equity fund.
3Note the purchase date. For debt funds, check whether units were bought on or after 1 April 2023.
4Count the holding period and compare it with the right limit: 12 months for equity, 24 months for other non-equity unlisted units.
5Compute the gain: sale value minus cost. Apply FIFO if only some units are sold.
6Apply the rate: 20% STCG, 12.5% LTCG above ₹1,25,000 for equity; slab rate for specified funds and IDCW.
7Check for loss set-off or exemption limits, then pick the matching option.

Quickest way: Fund type first, then clock

When to use it: Use this for MCQs that ask for a rate, a holding period or the right classification.

Ask: is it 65% or more equity? If yes, think 12 months, 20% and 12.5%.
If it is a specified debt fund bought after 1 April 2023, stop. Slab rate, no holding period test. Use the definition given in your syllabus version.
If it is a hybrid with 35% to 65% equity, think 24 months and 12.5%.
If the question says IDCW, think slab rate and TDS.
If the question says growth option, no tax until redemption.

Common mistakes in Taxation of Mutual Funds

Giving debt funds bought after 1 April 2023 long-term treatment after a long holding period.
Older rules gave debt funds LTCG with indexation after 36 months, and students still remember that.
Fix: For specified mutual funds bought on or after 1 April 2023, gains are taxed at slab rate regardless of holding period.
Applying the ₹1,25,000 exemption to STCG or to debt funds.
The exemption is quoted loosely as a mutual fund benefit.
Fix: It applies only to LTCG on equity-oriented funds (and other covered equity assets), added up for the whole financial year.
Using the old 15% STCG and 10% LTCG rates.
Older notes and workbooks show these rates.
Fix: Use 20% for STCG and 12.5% for LTCG on transfers on or after 23 July 2024, unless the question states otherwise.
Thinking IDCW is tax-free or taxed at a fixed rate.
Dividends were once tax-free in investors' hands because the fund paid a tax.
Fix: IDCW is now taxed in the investor's hands at slab rate. TDS is only an advance deduction, not the final tax.
Treating a switch between schemes as no sale.
No money reaches the bank account, so it looks like nothing happened.
Fix: A switch is a redemption plus a fresh purchase. Gains are taxable on the units switched out.
Taxing the whole sale value instead of the gain.
Students rush and skip the cost step.
Fix: Always compute gain = sale value − cost first, then apply the rate.

Worked examples

Example 1

Riya bought units of an equity-oriented fund for ₹5,00,000 in January 2023 and sold them for ₹6,50,000 in September 2025. She has no other capital gains this year and ignores surcharge and cess. How much LTCG tax does she pay?

Show the solution

Fund type: equity-oriented, so the 12-month test applies.
Holding period: January 2023 to September 2025 is more than 12 months, so the gain is long-term.
Gain = ₹6,50,000 − ₹5,00,000 = ₹1,50,000.
Exempt amount = ₹1,25,000, so taxable LTCG = ₹1,50,000 − ₹1,25,000 = ₹25,000.
Tax = 12.5% × ₹25,000 = ₹3,125.

Answer: ₹3,125 (before surcharge and cess).

Example 2

Arjun bought units of a debt fund in June 2023 for ₹4,00,000 and sold them after three years for ₹4,80,000. The fund is a specified mutual fund under the syllabus definition: it invests more than 65% of its assets in debt and money market instruments. His slab rate is 30%. Ignore surcharge and cess. What is the tax?

Show the solution

Fund type: specified mutual fund, bought after 1 April 2023.
Gains are deemed short-term, whatever the holding period, so three years does not matter.
Gain = ₹4,80,000 − ₹4,00,000 = ₹80,000.
No ₹1,25,000 exemption applies to this gain.
Tax at slab rate = 30% × ₹80,000 = ₹24,000.

Answer: ₹24,000 (before surcharge and cess).

Exam tips

Memorise the three buckets: equity (65% or more), specified debt, and other non-equity. Most questions test only which bucket applies.
Watch the purchase date in debt fund questions. Look for 1 April 2023.
The Finance Act 2024 widened Section 50AA and changed the specified mutual fund definition from 1 April 2025. Follow the definition given in your syllabus version.
Read the holding period closely. Exactly 12 months is short-term for equity, since long-term needs more than 12 months.
Check the option: growth, IDCW payout or IDCW reinvestment. IDCW is taxed even when reinvested.
Negative marking applies, so skip a rate-based question if you are unsure whether the older or newer rate is being tested.

Practice questions from Mutual Funds

Taxation of Mutual Funds: frequently asked questions

How are debt mutual funds taxed in India?

For specified mutual funds bought on or after 1 April 2023, all gains are taxed at your income tax slab rate, whatever the holding period. Debt fund units bought before 1 April 2023 and transferred on or after 23 July 2024 are long-term after more than 24 months, taxed at 12.5% without indexation. Otherwise the gain is taxed at slab rate. The purchase date and the fund's classification matter, so check them first.

What are the short-term and long-term capital gains rules for equity mutual funds?

Units held for 12 months or less give short-term gains, taxed at 20%. Units held for more than 12 months give long-term gains, taxed at 12.5% on the amount above ₹1,25,000 in a financial year. Indexation is not allowed.

How is IDCW from a mutual fund taxed?

IDCW is added to your income and taxed at your slab rate. The fund house deducts TDS at 10% for resident investors if IDCW crosses the yearly threshold. You adjust any difference when you file your return.

Is tax charged on growth option units every year?

No. In the growth option, tax arises only when you redeem or switch out units. Gains are then taxed under the capital gains rules for that fund type and holding period.