Taxation on Mutual Fund Investments: Equity, Debt and Hybrid Schemes

Navigating the complex world of mutual fund investments requires a thorough understanding of their taxability. The different types of mutual funds – equity, debt, and hybrid schemes – each carry distinct taxation rules. Under the Indian Income Tax Act’s Sec 80C, it is crucial to recognize the kind of mutual funds that qualify for tax deduction benefits. This comprehensive guide aims to shed light on this subject and demystify taxation aspects related to different mutual fund categories.

Mutual funds’ taxation largely depends on whether they are equity or debt oriented, and this classification guides the eligibility for tax deduction under Sec 80C. However, it is important to note that merely investing in equity-oriented mutual funds or related instruments does not automatically make one eligible for tax benefits under this section.

Only investments aligned with the Equity Linked Saving Scheme (ELSS) 2005, as notified by the Ministry of Finance, are eligible for such deductions, up to a limit of Rs. 1.5 lakh. Under SEBI’s guidelines issued in October 2017, mutual funds are categorized into Equity, Debt, and Hybrid schemes. Each of these categories carries different levels of risks, returns, market capitalization, and taxability implications.

EQUITY SCHEME

Under this, investments are primarily made in

• Equities and equity related instruments.
• Under Equity category, there are also further category of Large Cap, Mid cap & Small Cap stock. Further, this category is assigned on the basis of market Capitalization of companies. (Market capitalization= Current price per share * No of outstanding shares)

Table 1.0

Particulars	Large Cap Stock	Mid cap Stock	Small Cap Stock
1. Nature	Investment made in companies that are well established and have a significant market share.	Investment made in companies that have the ability to turn into large cap companies and tend to be more volatile	Investment made in companies that are relatively smaller in size and have significant growth potential.
2. Market Capitalization	It has market caps of Rs. 20,000 crore or more. >=Rs. 20,000 crore	It has market caps of more than Rs. 5000 crore but upto Rs. 20,000 crore 5000 crore <=20,000 crore	It has market caps of less than Rs. 5000 crore <= 5,000 crore
3. Risk	Low risk	Medium Risk	Higher risk
4. Returns	Returns are relatively lower  than mid cap and small cap.	Higher returns	Significant returns

CATEGORY OF EQUITY ORIENTED FUND

Table- 2.0

Particulars	Large, small & mid cap fund	Dividend yield Fund	Value fund	Sectoral Fund	ELSS scheme
1. Nature	Large– 80% investment made in large cap stock Mid-  65% investment in mid cap stock Small 65% investment in small cap stock (refer above table 1.0)	Invest in dividend yielding stock with at least 65% in stock	Investment made in fund that are currently under valued but are expected to perform better in long run	Investment in a particular sector of the economy such as infrastructure, banking, technology etc	Invests at least 80% in stocks in accordance with Equity Linked Saving Scheme, 2005, notified by Ministry of Finance. Lock in period of 3 years
2.Eligibility u/s 80C	Not eligible for deduction u/s 80C	Not eligible for deduction u/s 80C	Not eligible for deduction u/s 80C	Not eligible for deduction u/s 80C	Eligible subject to ceiling limit of Rs. 1.50 lacs
3.  Taxbility on redemption	Taxable under Capital gain
4. Period of holding	LTCG– If period of holding is 12 months or more. STCG- If period of holding is less than 12 months
5. taxability of LTCG/ STCG	LTCG-Where Long term capital gain exceed Rs. 1,00,000 then it is taxable @ 10% u/s 112A. STCG-Short term capital gain taxable @ 15% u/s 111A.

DEBT FUND

A debt fund (also known as income fund) is a fund that invests primarily in bonds or other debt securities. Debt funds invest in short and long-term securities issued by government, public financial institutions, companies, Treasury bills, Government Securities, Debentures, Commercial paper, Certificates of Deposit and others.

Debt funds can be categorized based on the tenor of the securities held in the portfolio and/or on the basis of the issuers of the securities or their fund management strategies, such as

– Short-term funds, Medium-term funds, Long-term funds

– Gilt fund, Treasury fund,  Corporate bond fund, Infrastructure debt fund

Generally, the Debt oriented Mutual funds are those fund where the investments of the proceeds is made as follows:

Equity = not more than 35%

Debt=  65% or in excess of 65%

Taxability Of Debt Fund ( Till A.Y. 2023-24)

For F.Y. 2022-23, taxability of debt fund is done according the period of holding which is tabulated below:

Particulars	Short Term	Long term
1. Period of holding	Not more than 36 month will be treated as STCG	36 months or more
2. Taxation	Taxable at slab rate	Taxable @ 20% after indexation

Taxability Of Debt Fund ( from A.Y. 2024-25)

For F.Y. 2023-24, taxability of Specified Mutual Fund (Debt fund) where not more than 35% of the proceeds are invested in the equity shares.

Taxability of Debt fund– Debt Oriented Mutual fund issued on or after 01.04.2023 will now be treated as Short term and taxable at slab rate irrespective of period of holding.

Particulars	Long term Debt fund	Short Term dent fund
Treatment	Treated as Short term, no indexation benefit.
Taxability	Taxable at slab rate

HYBRID FUND

Hybrid fund are a mix of equity and Debt securities.

– Equity oriented hybrid funds (Aggressive Hybrid Funds) are ideal for investors looking for growth in their investment with some stability. If the equity exposure exceeds 65% , then it is taxed like an equity fund.

            Taxation-

STCG- 15%

LTCG- Any gain exceeding Rs. 1 lakh taxed @ 10%

– Debt-oriented hybrid funds (Conservative Hybrid Fund) are suitable for conservative investors looking for a boost in returns with a small exposure to equity. If the equity exposure is less than 65%, then it will be taxed like an Dent fund.

Taxability- Treated as short term gain and taxable at slab rate.

Conclusion: Understanding the category of a mutual fund is vital in determining your tax liability accurately. While equity and debt schemes have their specific taxation rules, hybrid funds, as the name suggests, carry a mix of tax implications. Keeping in view the complexity of mutual fund taxation, it is advisable to understand these nuances thoroughly or seek professional help before making an investment decision. This way, you can not only optimize your returns but also remain compliant with the tax laws.