Mutual Fund Taxation in India: Residents & NRIs

Mutual funds aim to generate returns through capital gains (when you sell units at a profit) and dividends (periodic pay-outs). In India, these returns are subject to income tax, and the rules have evolved significantly in recent years. More recently, long-term capital gains (LTCG) tax rates and holding period criteria were revised in Budget 2024, and new rules were introduced for certain debt-oriented funds from 1 April 2023.

In this comprehensive blog, we break down how equity, debt, hybrid, and other mutual funds are taxed in FY 2025–26 for both resident and non-resident investors (NRIs). 

Mutual Fund Categories and Tax Holding Periods

For tax purposes, mutual funds are classified by their equity exposure, which determines the holding period for long-term capital gains and the applicable tax rates:

• Equity-Oriented Funds: Mutual fund schemes investing ≥65% of assets in Indian equities qualify as equity-oriented. This category includes pure equity funds (large-cap, mid-cap, etc.), Aggressive Hybrid funds (65–80% equity), equity index funds, Equity Linked Savings Schemes (ELSS), and arbitrage funds. Long-term capital gains treatment applies if held for more than 12 months; holdings for 12 months or less are short-term.
• Debt-Oriented Funds: Funds investing predominantly in debt instruments (bonds, money market instruments, etc.) with ≤35% equity exposure are treated as non-equity investments for tax. This includes debt mutual funds, liquid funds, gilt funds, gold funds/ETFs, international funds (since foreign equities don’t count as Indian equity), conservative hybrid funds (typically 10–25% equity), and other funds with minimal equity. Such funds if purchased after April 1, 2023, all gains are treated as short-term, regardless of holding period.
• Hybrid Funds: These are mixed asset funds. Taxation depends on the equity allocation:

1. Aggressive Hybrid Funds (equity ≥65%) are taxed like equity funds (12-month threshold).

2. Balanced/Moderate Hybrid Funds (equity >35% but <65%, e.g., some balanced advantage funds or multi-asset funds) have a 24-month threshold for long-term gains after recent changes.

3. Conservative Hybrid Funds (equity <35%) are taxed like debt funds (no long-term benefit for new purchases; see below).

Holding Period Summary: For FY 2025–26, equity-oriented investments are long-term if held >12 months, while other funds generally require >24 months to qualify as long-term (if they still qualify for LTCG treatment at all). If these criteria are not met, the sale is considered a short-term capital gain.

Below, we detail the tax rates for short-term and long-term gains across different fund types, and how the rules differ based on when the investment was made (before or after April 1, 2023).

Taxation of Mutual Fund Dividends (FY 2025–26)

Dividends from mutual funds are taxed as income in the hands of investors at their applicable slab rate. This has been the case since the Finance Act 2020, which abolished the earlier Dividend Distribution Tax regime. Key points about dividend taxation:

• Tax Rate

  Dividends are added to your total income under “Income from Other Sources” and taxed at your slab rate. There is no special lower tax rate for mutual fund dividends – they are taxed just like bank interest or salary income.

• TDS for Residents

  Mutual fund houses (AMCs) must deduct TDS @ 10% on dividend payments to residents if the aggregate dividend paid exceeds ₹10,000 in a financial year. You can claim credit for this TDS in your income tax return. (Dividend amounts up to ₹10,000 per year, per AMC, will not attract TDS for residents.)

• TDS for NRIs

  For non-resident investors, dividend pay-outs attract a higher TDS of 20% (plus applicable surcharge and cess) from the very first rupee. NRIs do not get the ₹10,000 threshold exemption on dividend TDS that residents enjoy. 

  
  NRIs cannot reduce this dividend TDS through Section 80C/80D deductions (such deductions are not applicable to dividend income for NRIs), but they may claim a refund by filing an ITR if their actual tax liability is lower (or use applicable DTAA provisions to seek relief).

Point to Note: Even though tax is deducted at source on dividends beyond the threshold, the ultimate tax liability depends on your total taxable income and slab. If your income puts you in a higher slab, you must pay the balance tax on dividends in your return. Conversely, if your slab rate is lower than the TDS rate (or you have no other income within taxable range), you can claim a refund for excess TDS. Always report your dividend income in the ITR, even if reinvested, since it is taxable once credited to you.

Capital Gains Tax on Mutual Funds 

The taxation of capital gains from mutual fund redemptions depends on two factors:

• the type of mutual fund (equity vs non-equity orientation) and
• the holding period of your investment (whether it qualifies as short-term or long-term as defined above).

Equity Mutual Funds (Equity-Oriented Schemes)

As per AMFI (Association of Mutual Funds in India), Equity-oriented Mutual Funds are those that invest at least 65% of their assets in equity shares of domestic companies. This category includes diversified equity funds, sectoral/thematic equity funds, Aggressive Hybrid Funds (65–80% equity), equity index funds, ELSS tax-saving funds (which have a 3-year lock-in), etc. Such funds are eligible for preferential capital gains tax rates akin to stocks.

Short-Term vs Long-Term: For equity-oriented units, holdings up to 12 months are treated as short-term, and holdings longer than 12 months are long-term for tax purposes.

Tax Rates (Residents)

• Short-Term Capital Gains (STCG)

  Taxed at 20% (plus cess and surcharge) in FY 2025–26. This rate is applicable to gains from equity fund units sold within 12 months. 

• Long-Term Capital Gains (LTCG)

  Taxed at 12.5% on gains exceeding the annual exemption threshold of ₹1.25 lakh. No indexation benefit is allowed on equity LTCG, but the flat low rate and exemption serve as relief. The holding period should be more than 1 year to qualify for LTCG.

Tax Rates (NRIs)

NRIs pay the same tax rates on capital gains; however, TDS is deducted on redemption:

• Equity STCG: 20% TDS is withheld on short-term gains for NRIs (this corresponds to the 20% tax rate).
• Equity LTCG: 12.5% TDS is typically withheld on long-term gains. The ₹1.25 lakh annual exemption technically applies to NRIs as well, though in practice the withholding might be on the full gain or on the amount above ₹1.25L depending on the intermediary’s process. NRIs should file an Indian tax return to claim any refund if TDS is over-collected.

Special Cases: Equity-oriented funds include Equity Linked Savings Schemes (ELSS), which offer a tax deduction of up to ₹1.5 lakh under Section 80C (for residents opting for the old regime). ELSS funds have a mandatory 3-year lock-in, so any sale will always result in LTCG (never STCG). The LTCG from ELSS is taxed the same way (first ₹1.25L exempt, 12.5% beyond that). Also note, unit holders do not pay any tax at the time of switching schemes within an AMC’s ULIP (which is different from mutual funds), but for mutual fund switches or redemptions, the above capital gains taxes apply.

Debt Mutual Funds and Other Non-Equity Funds

Debt mutual funds invest primarily in fixed-income securities like bonds, government securities, treasury bills, etc. For tax purposes, any mutual fund scheme with ≤35% equity exposure is treated as a non-equity fund (often referred to as “debt funds” in taxation context, even if the fund is a gold or international fund). 
This category covers pure debt funds, Liquid/Ultra-short funds, Gilt funds, Fixed Maturity Plans (FMPs), Gold ETFs/Funds, International equity funds (since they have 0% domestic equity), Conservative Hybrid funds (typically ~20% equity), etc. 

All gains are treated as short-term, irrespective of holding period, if the fund’s equity allocation ≤35%. Such investments no longer get any indexation or LTCG benefits, even if held for many years.

Tax Rates (Residents) for Debt and Non-Equity Funds

All gains are treated as short-term and taxed as per your income tax slab.

Tax Rates (NRIs)

For non-residents, the tax on debt fund gains is also at slab rates. However, TDS for NRIs on debt fund redemptions is generally applied at the maximum rate:

• For FY2025-26, the AMC will deduct 30% TDS (plus cess) on the gains, since such gains are taxed as regular income (and 30% is the highest slab rate for individuals).

Hybrid Mutual Funds (Balanced Funds)

Hybrid funds invest in a mix of equity and debt. Their tax treatment depends on their equity component:

• If equity ≥65% (e.g., Aggressive Hybrid Funds, Equity Savings funds), they are taxed as equity funds (already covered above).

• If equity is between 35% and 65%, these funds straddle between pure equity and pure debt categories. 

  
  Examples include some Balanced Hybrid Funds (40–60% equity) and certain Dynamic Asset Allocation/Balanced Advantage Funds (which may not always maintain 65% equity).

1. The LTCG holding period is 24 months.
2. Long-term gains on these funds are taxed at 12.5% (without indexation), similar to debt funds now, but importantly they do get a long-term classification if held >24 months (unless the fund’s equity is ≤35%, in which case it’s treated as debt fund under Section 50AA).
3. In essence, any mutual fund with >35% equity is now allowed LTCG treatment (12.5% tax) after 24 months, even if it doesn’t hit the 65% mark to be an “equity-oriented” fund. Funds with ≤35% equity (pure debt category) get no LTCG benefit if bought after April 2023.

• If equity <35%, they fall under the debt fund rules discussed above (e.g., Conservative Hybrid Funds have only 10–25% equity, so they follow non-equity taxation).

Summary Table of Capital Gains Tax Rates (FY 2025–26)

Below is a simplified table of tax outcomes by fund type, purchase date, and holding period for resident investors:

Taxation/TDS for Non-Resident Investors (NRIs)

The table below (for illustration) shows NRI TDS rates corresponding to various scenarios in 2025 (excluding surcharge and cess):

NRIs should note that these TDS are not the final tax – if your actual liability is lower (for example, you fall in a lower slab or your equity LTCG didn’t exceed ₹1.25L), you can claim a refund. Conversely, if your actual tax is higher (due to surcharge for high income, etc.), you must pay the balance. Filing an Indian tax return is important to reconcile TDS with actual tax due. Also, NRIs from countries that have a Double Taxation Avoidance Agreement (DTAA) with India might benefit from lower tax rates on certain incomes.

• No TDS for Residents on Capital Gains: It’s worth mentioning that resident Indians do not have any TDS deducted on mutual fund redemption proceeds. They are expected to pay any capital gains tax via advance tax or self-assessment. NRIs are the only ones subject to TDS on such gains.
• Compliance: NRIs must provide an updated PAN to the mutual fund and also qualify as NRI under FEMA to invest. Upon redemption, they receive a TDS certificate (Form 16A) for the tax deducted. They should file an ITR in India to declare these gains and claim any refunds or pay additional tax if applicable. If an NRI’s total Indian income (including gains) is below the basic exemption limit, they can potentially get a full refund of TDS, as NRIs are also entitled to the basic exemption (₹2.5 lakh in old regime; note that special rates on capital gains may not allow full usage of basic exemption, but that’s a complex area).