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How to minimize tax on mutual fund returns?

If you want to minimize tax on mutual fund returns, first it’s important to understand how mutual funds are taxed.

How are mutual fund returns taxed?

Mutual fund taxation on returns varies according to the holding period and type of fund. The holding period is the duration up to which you remain invested in the mutual fund. The period of investment or holding period plays a significant role in determining the quantum of tax.

Holding periods are classified as short-term and long-term, and again this classification varies according to the fund. The table below explains how it works.

FundsShort-termLong-term
Equity Funds < 12 months => 12 months
Balanced Funds (more than 65% equity exposure) < 12 months => 12 months
Balanced Funds (less than 65% equity exposure) < 36 months => 36 months
Debt Funds < 36 months => 36 months
Tax rates based on holding period [2]
  • Short-term returns on equity funds (those with more than 65% equity exposure) are taxed at the rate of 15%.
  • Short-term returns on debt mutual funds are considered part of taxable income.
  • Long-term returns above ₹1 lakh on equity mutual funds are taxed at 10%.
  • Long-term returns on debt mutual funds are subject to a 20% tax but are eligible for indexation benefit, which lowers your tax by factoring inflation.
How are mutual funds SIPs taxed?

Mutual fund taxation for a systematic investment plan (SIP) is a bit tricky. Each instalment of a mutual fund SIP is considered a new investment. If you want to withdraw your entire corpus of SIPs along with returns after 1 year, only the returns on the first instalment you started a year ago will be tax-free. You will have to pay short-term capital gains tax at applicable rates on returns for the remaining SIPs.

How to minimise tax on mutual fund returns

One of the best ways to save tax on mutual fund returns is to invest in an equity-linked savings scheme (ELSS). Though ELSS has a lock-in period of 3 years and is subject to long-term capital gains (LTCG) tax, it is still a useful tax-saving tool.

ELSS mutual funds investment helps to reduce your tax liability by up to ₹1.5 lakh. Also, returns up to ₹1 lakh is tax free. You can also reduce your tax liability on mutual fund returns while maximising returns by investing in equity-linked schemes for the long-term.

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