In FY 2026-27, equity mutual funds (≥65% domestic equity) are taxed at 20% STCG if held 12 months or less and 12.5% LTCG above that, with ₹1.25 lakh of LTCG exempt per year. Debt funds (≤35% equity) are taxed at your slab rate regardless of holding period. Hybrid funds (35–65% equity) use a 24-month threshold. Source: Finance (No. 2) Act 2024, incometaxindia.gov.in.
Key Takeaways
- Equity Holding Period: Only 12 months is required to qualify for the lower Long-Term Capital Gains (LTCG) rate of 12.5%.
- Higher Exemption Limit: Cumulative long-term capital gains on equity shares and equity mutual funds are tax-exempt up to ₹1.25 Lakh per year.
- Slab Tax on Debt: All debt fund gains are treated as short-term income and added directly to your taxable salary.
- Indexation is Eliminated: The benefit of adjusting purchase prices for inflation (indexation) has been completely removed across all mutual fund types.
- Hybrid Fund Arbitrage: Balanced funds with 35%-65% equity offer a middle ground with a flat 12.5% LTCG after a 24-month holding period.
1. Classification of Mutual Funds for Tax Purposes
In India, capital gains tax is not calculated based on the name of the scheme, but on the percentage of domestic equity exposure in the fund. The tax department categorizes mutual funds into three distinct classes:
- Equity-Oriented Funds: Schemes that invest 65% or more of their total corpus in domestic equity shares. This includes diversified equity funds, ELSS, large/mid/small-cap funds, sectoral funds, and aggressive hybrids.
- Debt-Oriented Funds: Schemes that invest 35% or less of their total corpus in equity shares. This includes liquid funds, ultra-short duration funds, and corporate bond funds. Gold ETFs, gold funds and international fund-of-funds are no longer taxed as debt funds for units sold from 1 April 2025: gains become long-term after 12 months (listed ETFs) or 24 months (fund-of-funds) and are taxed at 12.5%.
- Other Hybrid / Conservative Hybrid Funds: Schemes that invest more than 35% but less than 65% in domestic equity. This includes balanced hybrid funds, conservative hybrids, multi-asset allocation funds, and arbitrage combinations that do not meet the 65% equity threshold.
2. Equity Mutual Fund Tax Rules (2026)
If you redeem units of an equity mutual fund, the tax is calculated based on how long you held the units:
- Short-Term Capital Gains (STCG): Applicable if the units are held for 12 months or less. The gain is taxed at a flat rate of 20% (plus applicable surcharge and 4% cess).
- Long-Term Capital Gains (LTCG): Applicable if the units are held for more than 12 months. The gain is taxed at a flat rate of 12.5% (plus applicable surcharge and 4% cess). However, you get a tax-free exemption on cumulative equity gains of up to ₹1.25 Lakh per financial year. Only gains exceeding this limit are taxed.
Example: If you buy equity mutual fund units for ₹5 Lakhs and redeem them after 18 months for ₹7 Lakhs, your total capital gain is ₹2 Lakhs. Since the holding period was over 12 months, it is taxed as LTCG. The first ₹1.25 Lakh is tax-exempt. The remaining ₹75,000 is taxed at 12.5%, which equals a tax liability of ₹9,375 (plus cess).
3. Debt Mutual Fund Tax Rules
The rules for debt mutual funds were altered to remove indexation benefits. For debt funds acquired on or after April 1, 2023, there is no distinction between long-term and short-term capital gains.
- Slab-Rate Taxation: Whenever you redeem debt mutual fund units, all gains are added directly to your total taxable income. The gains are taxed at your applicable personal income tax slab rate (e.g., 5%, 10%, 20%, or 30% under the new or old tax regimes).
- This makes debt mutual funds tax-equivalent to fixed deposits. However, they still offer the benefit of deferring tax until redemption, unlike FDs where interest is taxed annually on an accrual basis.
4. Hybrid Mutual Fund Tax Rules (35% to 65% Equity)
Hybrid funds that hold a moderate allocation of equity shares (between 35% and 65%) occupy a distinct tax bracket:
- Holding Period Threshold: The dividing line between short-term and long-term gains is 24 months.
- Short-Term Capital Gains (STCG): If held for 24 months or less, gains are added to your income and taxed at your slab rates.
- Long-Term Capital Gains (LTCG): If held for more than 24 months, gains are taxed at a flat rate of 12.5% without the benefit of indexation. Unlike equity-oriented funds, there is no ₹1.25 Lakh annual tax exemption for this category.
5. Summary of Mutual Fund Taxation Rates (2026)
| Fund Category | LTCG Threshold | STCG Tax Rate | LTCG Tax Rate | Exemption Limit |
|---|---|---|---|---|
| Equity-Oriented (≥ 65% Equity) | > 12 Months | 20% | 12.5% | ₹1.25 Lakh per year (combined) |
| Hybrid & Gold (35% to 65% Equity) | > 24 Months | Slab Rates | 12.5% | None (Taxed from first rupee) |
| Debt-Oriented (≤ 35% Equity) | N/A | Slab Rates | Slab Rates | None |
6. Tax-Saving Mutual Funds (ELSS) Rules
Equity Linked Savings Schemes (ELSS) are unique tax-saving mutual funds. They allow you to claim a tax deduction of up to ₹1.5 Lakhs under Section 80C of the Income Tax Act (if you choose the Old Tax Regime). However, they have a mandatory lock-in period of 3 years.
Once the lock-in expires, any redemption is taxed as an equity-oriented long-term capital gain. This means you will pay 12.5% tax on the portion of your cumulative long-term gains that exceeds the ₹1.25 Lakh annual exemption limit.
Optimize Your Portfolio for Tax Efficiency
Different mutual funds carry widely different tax implications. Our team at Hatlet Ventures can help you align your asset allocations, schedule mutual fund withdrawals to harness the annual ₹1.25 Lakh LTCG exemption, and build a tax-efficient plan.
7. Frequently Asked Questions (FAQs)
How is the holding period calculated for SIP transactions?
For systematic investment plans (SIPs), each monthly instalment is treated as a separate investment. The holding period of 12 or 24 months is calculated from the exact date that particular instalment was made. To gain LTCG tax benefits, each instalment must complete its respective long-term duration.
Is there a tax when switching from one mutual fund to another?
Yes. A switch is treated as a redemption (sale) followed by a new purchase. Therefore, switching out of a scheme triggers capital gains tax on the redeemed units, depending on whether it is an equity, debt, or hybrid fund and the holding period.
Do mutual funds deduct TDS upon redemption for Indian residents?
No, AMCs do not deduct Tax Deducted at Source (TDS) on redemptions made by resident Indian investors. You are responsible for calculating your capital gains and paying the tax when filing your annual Income Tax Return (ITR).
What is tax harvesting in mutual funds?
Tax harvesting is the strategy of redeeming equity mutual fund units once a year to realize long-term capital gains up to the tax-free limit of ₹1.25 Lakh, and then immediately reinvesting the proceeds into the same or a similar fund. This resets your cost of acquisition higher, lowering your future taxable capital gains.
Read next: What changes under the new Income Tax Act, 2025.
Disclaimer: This article is for education only and is not investment, tax or legal advice. Figures and rules are stated as understood on the date shown and can change. Return figures are illustrative or historical, not guaranteed; past performance does not guarantee future results. Mutual fund investments are subject to market risks; read all scheme-related documents carefully. Insurance is the subject matter of solicitation. Hatlet Ventures is an AMFI-registered mutual fund distributor (ARN-345155), not a SEBI-registered investment adviser.
Sri Balaji is the founder of Hatlet Ventures in Tiruppur, Tamil Nadu. He is a NISM Certified Research Analyst, AMFI Registered Mutual Fund Distributor (ARN-345155), IRDAI Registered Insurance Agent (1911251001) and APMI Registered PMS Distributor (APRN09158). With 8+ years of experience, he has guided 500+ families across Tamil Nadu in SIP, mutual funds, insurance planning, and portfolio management. All content on this blog is reviewed for accuracy and updated regularly.