Taxes are a vital component of mutual fund investments. Check out this post to know how Short-Term Capital Gains or STCG are taxed in mutual funds.

When analyzing a mutual fund scheme, most investors focus on aspects like its track record, fund manager, portfolio constituents, and exit load. Unfortunately, the taxation seldom receives the level of importance it deserves. After all, post-tax returns are the actual returns you generate from your mutual fund investment.

So, how are mutual fund gains taxed? What is Short-Term Capital Gain (STCG) in mutual funds? Let’s find out.

Mutual Fund Taxation

Profit from a mutual fund investment can either come from IDCW (Income Distribution cum Capital Withdrawal), previously known as dividends, or capital gains.

• Income Distribution cum Capital Withdrawal

  You receive IDCW when the mutual fund scheme divides a portion of the generated profit among all the investors. As per the current tax laws, mutual fund IDCW is taxable in the hands of the investors. Therefore, the IDCW is added to the investor's taxable income and taxed as per their tax slabs.

• Capital Gains

  The capital gains are profits mutual fund investors generate on selling their units. For tax purposes, the capital gains are divided into Long-Term Capital Gains (LTCG) and Short-Term Capital Gains (STCG).

Short-Term Capital Gains (STCG) Tax on Mutual Funds

The tax applicable to STCG generated from a mutual fund investment is known as STCG tax. However, the definition of ‘short-term’ varies for mutual fund categories.

For instance, if you’ve invested in equity funds, you’ll generate STCG on redemption within 12 months from the date of investment. But for debt schemes, you’ll generate STCG by redeeming the investment within 36 months from the date of investment.

Apart from the holding period to define STCG on mutual funds, even the STCG tax rate varies between fund categories.

STCG Taxability for Various Mutual Fund Categories

• STCG Tax on Equity Mutual Funds

  Equity mutual funds are schemes investing at least 65% of their portfolio in equity and equity-related instruments. As per the tax laws, STCG tax on equity mutual funds or on gains from holding the investment for less than 12 months is 15% + cess + surcharge.

• STCG Tax on Debt Mutual Funds

  Debt funds are schemes that invest primarily in debt securities As per the tax laws, STCG from debt funds or gains when investment is redeemed within 36 months are added to the investor's taxable income and taxed as per their slab rate.

• STCG Tax on Hybrid Mutual Funds

  Hybrid mutual funds invest in a mix of equities and debt securities. Depending on the investment portfolio of a hybrid scheme, it can be equity-oriented or debt-oriented. Equity-oriented hybrid schemes have at least 65% of their portfolio invested in equity, whereas debt-oriented hybrid schemes allocate a larger portion to debt instruments with 15%-25% equity allocation.
  
  Tax laws of equity mutual funds are applicable for equity-oriented hybrid funds. So, STCG from an equity-oriented hybrid fund will be taxed at 15% + cess + surcharge. Similarly, if it is a debt-oriented hybrid scheme, STCG will be taxed as a debt mutual fund, which means the gains will be added to the investor’s taxable income and taxed as per their income tax slab.

Mutual Fund STCG Overview

Here’s a quick overview of how the holding period varies for STCG in different fund categories and how the gains are taxed-

Mutual Fund STCG Example

Dipesh invested Rs. 2 lakhs in an equity mutual fund and Rs. 1 lakh in a debt mutual fund on January 1, 2021. He redeemed the investment made in the equity scheme on October 1, 2021. As the holding period for this equity fund investment is less than 12 months, the gains from the investment will be termed STCG and taxed at 15% + cess + surcharge.

Then on October 1, 2022, he redeemed the investment made in the debt mutual fund. The holding period for the investment is 22 months which is within the limit of 36 months prescribed for STCG in debt mutual funds. So, the STCG from the investment will be added to his taxable income and taxed as per his tax slab.

STCG Taxation on SIP

If you’re investing in mutual funds through a Systematic Investment Plan or SIP, here’s how the short-term gains will be taxed-

Click Here to Know What is SIP?

Let's assume Dipesh started a SIP in an equity mutual fund on October 1, 2021. After investing through SIP every month for 12 months, he decided to redeem his investment on November 1, 2022.

So, the SIP amount invested in the 1st month has remained invested for more than 12 months. Thus, the STCG tax will not be applicable to the gains he generated from the mutual fund units he received in the first month. The gains from 1st month’s SIP will come under the purview of the LTCG (Long-Term Capital Gains) tax.

However, STCG tax at 15% + cess + surcharge will be applicable on SIPs from 2nd month onwards as they are yet to complete a period of 12 months.

For illustration purposes only. Actual results may vary.

The past performance of the mutual funds is not necessarily indicative of future performance of the schemes.

Click Here to Calculate Your SIP

Other Tax on Mutual Fund Investment

Apart from Short-Term Capital Gain in a mutual fund, investors should also know about Securities Transaction Tax (STT). It is a tax levied by the government on the purchase or sale of equity mutual funds and equity-oriented hybrid mutual funds. The current STT rate is 0.001%.

However, STT does not apply to debt and debt-oriented hybrid mutual funds.

Understand Mutual Fund Taxes to Navigate Them Efficiently

Before investing in mutual funds or working on a redemption strategy, it is essential to be aware of the tax implications and aspects like STCG.

Understanding taxes will add more clarity and confidence to your investment decisions, allowing you to take maximum advantage of a convenient and flexible investment option like mutual funds.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.