Besides investing in the best mutual funds, you must also know how they are taxed to make the most of your mutual fund investments. Read on to know about the taxation of debt and equity mutual funds and to find tips on how you can maximise your mutual fund returns by saving more tax.
The difference in taxation for equity and debt mutual fund schemes
The Income Tax (IT) department defines long- and short-term capital gains differently for equity and debt mutual fund schemes. For equity-linked mutual fund schemes, the gains you earn after selling your mutual fund units held for up to 1 year are classified as short-term capital gains (STCG). However, if you hold your units for more than a year before redeeming them, they are classified as long-term capital gains (LTCG). The IT department levies a 15% tax rate on STCG earned from equity mutual funds and applies a 10% LTCG tax rate for equity funds in addition to a tax deduction of up to ₹ 1 lakh.
In the case of debt mutual funds, the concept of LTCG has been scrapped by the IT department following the passing of the Finance Bill, 2023. Hence, all gains earned from debt mutual funds are now treated as STCG and they are taxed according to the investor’s income tax slab rate. Additionally, debt fund investors cannot benefit from indexation after the passing of the Finance Bill 2023.
Tips to maximise your mutual fund returns by saving more tax:
You must look to reduce your tax liabilities when you invest in a mutual fund scheme. Here are two tips that you can follow to maximise your returns by saving more tax:
Adopt the tax harvesting strategy to save more tax:
The tax harvesting strategy involves selling your equity mutual fund units every year and re-investing them in the same scheme to earn LTCG. Suppose an investor invested ₹5 lakh in an equity mutual fund on 1st February 2024 and received 12% returns. On 1st March 2025, their investment returns and capital gains will look as follows:
| Lump-sum investment on 1st February 2024 | ₹ 5 lakh |
| Returns | 12% |
| Investment value on 1st March 2025 | ₹ 5.6 lakh |
| Long-term capital gains on 1st March 2025 | ₹ 60,000 |
If the investor redeems their investment on 1st March 2025, they will not have to pay capital gains tax since the capital gains do not exceed the ₹1 lakh limit. Now, if they reinvest these earnings back into the scheme on 2nd March 2025, assuming 12% returns on their investment, here is how their investment will grow by 5th March 2026:
| Lump-sum investment on 2nd March 2025 | ₹ 5.6 lakh |
| Return generated | 12% |
| Investment value on 5th March 2026 | ₹ 6.27 lakh |
| Long-term capital gains on 20th March 2026 | ₹ 67,200 |
Since ₹67,200 does not exceed the ₹1 lakh limit, the investor will not have to pay any tax. This is how the tax harvesting strategy can help equity fund investors pay lesser tax.
Invest in a tax-saving mutual fund scheme: Another effective way to save more tax is investing in a tax-saving mutual fund scheme like an ELSS (Equity-Linked Savings Scheme). These mutual fund investments help you claim up to ₹ 1,50,000 annually as tax deductions under Section 80C of the Income Tax Act.
You can use a mutual fund calculator to calculate your mutual fund returns at the end of its investment horizon. Doing so can help you effectively plan your taxes too.
Also Read: Mutual Fund SIP Calculator: Things to Know
