ABSTRACT
There are various taxes surrounding the transaction of investing in mutual funds. It includes various aspects such as tax on the individuals in the form of capital gains tax, stamp duty on the transaction, dividend income on the dividend distributed by the fund owner and the securities transaction tax for selling the units in the mutual funds. Moreover, there are various other taxes such as TDS to be collected by the AMC, the GST on brokerage and various taxes collected from other entities present in the transaction of a mutual fund. This article will provide a detailed insight into how these taxes are collected and the provisions under which they are collected.
INTRODUCTION
Mutual funds in India have gained popularity with the “Mutual Funds Sahi Hai” campaign initiated by the Association of Mutual Funds in India (AMFI). The basic premise of mutual funds is that investors purchase units managed by Asset Management Companies (AMCs), which invest in shares or debt securities. Investors receive profits or incur losses based on market fluctuations. As of January 31, 2025, India’s total Assets Under Management (AUM) in mutual funds stand at Rs. 67.25 lakh crores (67.25 trillion rupees), with prominent fund houses such as ICICI Prudential Mutual Fund, SBI Mutual Fund, and HDFC Mutual Fund.
Despite the growing popularity, most retail investors (individual investors) remain unaware of the various taxes associated with mutual fund transactions. The Income Tax Act of 1961 (future in the Income Tax Bill, 2025) and the Central and State/UT GST Acts impose several taxes on these transactions. Understanding these taxes requires analysing different stages. The first aspect would be a tax on the Mutual Fund Distributors and Agents who provide the mutual fund to the folio holders (account of individuals). There are various brokerages, SEBI charges, Securities Transaction Tax and Stamp Duty. While holding the mutual funds, there are taxes on the dividends distributed by the mutual fund managers which are subject to Dividend Distribution Tax. Lastly, there are various taxes such as capital gains tax, expense ratio, and exit load, among other taxes that are imposed. The taxes on the transaction of the purchase and selling of the mutual funds could also be differentiated based on who is liable to pay tax, however, there are various taxes that are collected by the folio holder but paid by other individuals which makes the flow of the taxes difficult to understand.
PRE – PURCHASE STAGE
Purchasing a mutual fund entails buying units of a fund managed by an AMC, which invests in various assets, including debt, stocks, and bonds. Based on these investments, mutual funds are divided into various types such as Equity Mutual Funds, Debt Mutual Funds and Hybrid Mutual Funds. These mutual funds can be purchased either directly from the AMC or the popular method of purchasing through a broker.
Entry load
Entry load was a one-time charge levied on the mutual fund transactions as per the discretion of the mutual fund house. This fee, however, stands removed as of 2009 by SEBI via Circular No. SEBI/IMD/CIR No. 4/ 168230/09 dated 30/06/2009.
Transaction charge
Transaction charge is a one-time charge introduced via SEBI circular no. CIR/IMD/DF/13/2011 dt. 22/08/2011 which imposes charges on the investments made via a mutual fund distributor (MFD), wherein the MFD has the right to “opt-in” or “opt-out” of imposing this fee on the transactions. MFDs are experts who help investors in buying, selling or managing mutual funds, and these charges are imposed as per the relevant SEBI rules. The charge is Rs. 150 for first-time investors above Rs. 10,000 and Rs. 100 for any investment above the amount of Rs. 10,000, including for SIPs (Systematic Investment Plans). Most of the MFDs have not opted out of this charge including SBI, NJ IndiaInvest, HDFC Bank and Axis Bank.
Brokerage
Brokerage is not a direct fee, but the cost incurred by the MFDs or distributors for buying or selling mutual fund units, which is recovered through the brokerage charge. These charges are different and in addition to the other fees levied on the mutual funds amount to a percentage of the invested money. Brokerage charges vary by the broker and are often set lower to attract customers. Brokerage falls under the category of “Financial and related services” as per Notification No. 11/2017 – Central Tax (Rate), which is subjected to 18% GST. This extends to all the consideration received in lieu of brokerage services including that of the transfer of shares. Brokerage collected by brokers such as Groww, Zerodha, AngelOne, etc are also subject to a GST of 18%, irrespective of the type. This GST is included in the brokerage and is not separately visible to the investors.
Further, compliance of the brokers includes the registration with the GST council as per Section 25(3) of the CGST Act, 2017 and the GST payable by them is subject to the conditions provided for “pure agent” in Rule 33 of the CGST Rules, 2017. The detailed guide on the taxation of the brokers is provided in the FAQs on Stockbrokers published by the CBIC dated 27.12.2018. Moreover, the composition scheme is also made available to the brokers vide CGST (Rate) Notification No. 2/2019 dated 07.03.2019 which will reduce the compliance burden of the brokers.
Stamp Duty
Stamp duty is a one-time charge imposed on the purchase or transfer of a Mutual Fund of all types. Stamp Duty on the Mutual Funds transactions was made effective from July 2020 via Notification No. S.O. 1226(E) and G.S.R. 226(E) dated 30.3.2020, issued by the Department of Revenue, Ministry of Finance, Government of India. These notifications made a mandatory collection of the stamp duty for issue and transfer of all securities in the Indian Stock Market, which includes the Mutual Funds. Currently, the rate for the issue of mutual funds units (securities in general) is 0.005% and the transfer of mutual funds from one folio to another is 0.015%. This cost is deducted before allocating Net Asset Value (NAV) units to investors. For instance, if an investor invests Rs. 10,000, approximately Rs. 9,950 is allocated as mutual fund units. These charges add up significantly when multiple transactions are carried out.
HOLDING PERIOD
Although there are various charges and taxes imposed prior to the purchase of the Mutual Funds, there are significantly more taxes post-purchase. These include the expense ratio imposed by the Mutual Fund Houses and the Dividend Distribution Tax to be collected by the Fund House prior to issuing the dividends to the mutual fund owner. These charges vary depending upon the Fund House, the rate of dividend, and the frequency of change in the holding, among various other factors, and can be imposed till the mutual fund has been redeemed by the folio holder.
Total Expense Ratio
Expense Ratio, also known as Total Expense Ratio (TER), is an annual charge, not a tax, imposed by the AMCs acting as the main source of income for them. It is calculated as a percentage of the NAV of AUM. This is due to the increased management costs, legal compliance, and transaction fees and may be changed depending on the expenses incurred by the AMC. TER consists of Base TER and Total TER. Base TER includes the various costs that have been mentioned, and it is where most of the changes in the TER occur.
The formula to calculate the Base TER is “the scheme’s total expense incurred divided by the AMC’s total AUM.” This base TER is higher for more actively managed funds as the “total expense” of the fund house will be relatively higher when compared to the expense of less actively managed funds. Investing in a mutual fund via an intermediary such as a distributor, agent or broker, AMCs pay commissions to them leading to higher TER. Moreover, Base TER does not include certain expenses and GST as per the SEBI (Mutual Funds) Regulations, 1996.
Total TER on the other hand includes Base TER along with the expenses included in Regulation 52 (6A) (b) and 52 (6A) (c) of the SEBI (Mutual Funds) Regulations, 1996, which state an additional percentage of the expense can be claimed for the mutual funds which are invested from cities which have lower penetration of mutual funds, and additional management fee of 1% for certain funds. However, this additional fee of 1% now stands removed as per the SEBI (Mutual Fund) (Amendment) Regulations, 2010, with effect from 29.07.2010. Total TER also includes the collection of the GST, which is taxed at a rate of 18% as per the Central Tax (Rate) Notification No. 11/2017 dated 28.06.2017. This rate of 18% is calculated on the total TER imposed on the Mutual Fund holder. For example, if the expense ratio of a mutual fund is 1% then the GST on that expense ratio would be 1% * 0.18 = 0.18% of the NAV.
Prior to the implementation of the GST, the Service Tax was imposed on mutual funds management services at 15%. GST has also mandated the registration of the fund houses and distributors under the GST Acts if the person has more than Rs. 20 Lakhs as turnover in a financial year.
SEBI (Mutual Funds) Regulations, 1996 provide for the maximum TER for mutual funds based on the AUM where the TER is proportionally increased with the increase of AUM. The maximum TER limit of 2.25% for equity mutual funds and 2.00% for all other types of mutual funds is stipulated under the guidelines.
Dividend Distribution Tax
Dividend Distribution Tax (DDT) was previously levied on the payment or declaration of the dividend (excess profit of a company) by listed companies. It was collected prior to handing out the dividend and was paid to the government by the companies. Similarly, the AMCs had the obligation to deduct DDT from the dividend payout to the folio holder which was paid by the AMCs to the Tax Department. However, DDT was abolished in the Finance Act of 2020 wherein the dividends are now taxed in the hands of the shareholders and the liability of the tax has been shifted from AMCs. Currently, dividends fall under the head “Income from Other Sources” where the tax rate of the financial year and the tax as per the applicable tax slab would be applicable during the filing of the Income Tax Returns.
AMCs are now only required to deduct 10% as TDS under Section 194K of the Income Tax Act, 1961 (Section 393, Table: S.No. 4 of the Income Tax Bill, 2025) if dividend income exceeds Rs. 5,000 in a Financial Year. Investors can claim this TDS when filing their tax returns.
SELLING OF MUTUAL FUNDS
Although there are various charges along with taxes collected during the holding period of the mutual funds, there are various other charges that are applicable while the mutual funds have been redeemed. This includes the capital gains tax, security transaction tax and TDS. Apart from the taxes, various charges by the AMCs such as exit load and switching fees also exist, depending upon the holding period and the type of mutual fund.
Capital Gains Tax – Short-term and long-term
Capital Gains Tax is a tax collected under the Income Tax Act, of 1961 where the levy of tax is based on the capital gains realised by the individual, which might be adjusted for inflation. This capital gains tax is imposed differently for different types of assets. For mutual funds, there are two types, Short-Term Capital Gains Tax (STCG) and Long-Term Capital Gains Tax (LTCG). The taxes are determined based on the holding period of the mutual fund and the type of mutual fund that was invested. “The holding period is the duration in which the asset was held by the person.”
An equity mutual fund redeemed is categorised to be an STCG if the holding period was less than 12 months, whereas any holding period of more than 12 months is categorised as LTCG. For these STCG gained from equity mutual funds, the tax rate is applied at 20% if the sale of the mutual fund is made from 23rd July 2024 as amended by the Finance Act of 2024. Prior to the amendment, the applicable rate was 15% for the realisation of STCG. The sales categorised as LTCG are tax-free up to the limit of Rs. 1.25 lakhs, above which the tax rate of 12.5% would be applicable. Indexation benefit, which in simple terms adjusts the invested amount for inflation to grant a higher exemption, is not applicable to LTCG derived from equity mutual funds. These rates are provided under Section 10 (23D) of the Income Tax Act, 1961 (Schedule VII, Table: S. No. 20 of the Income Tax Bill, 2025).
Debt mutual funds have different rules than equity mutual funds as these are taxed as per the slab rate. The debt mutual funds have a holding period of 36 months, prior to which the realised amount would be considered as STCG whereas the realisation of the amount post 3 years would be considered as LTCG. However, these classifications no longer are necessary as both STCG and LTCG debt funds are taxed as per the individual’s slab rate, and no separate tax rate has been specified with the amendment carried out by the Finance Act of 2023. Prior to the amendment, the tax rate for LTCG debt funds was imposed at 20%, with the indexation benefit provided to this calculation. The indexation benefit has also been removed with the amendment proposed by the Finance Act of 2023.
It is important to note that the tax rate is imposed on capital appreciation, which is calculated by subtracting the capital that was invested from the capital that was received when the mutual fund was realised (sold). Another form of mutual funds is the Funds of Funds (FOFs) which invest in other mutual funds. The FOFs that hold 90% equity funds would have a different form of taxation. The holding period in this category is 24 months for realising the mutual fund prior to which it will be considered as a STCG whereas after 24 months would be considered as LTCG. The rate of tax for STCG FOFs is slab rate whereas the rate would be 12.5% if it is an LTCG FOF. This has been provided under Section 112A of the Income Tax Act 1961 (Section 198 of the Income Tax Bill 2025). However, these provisions are only applicable if the amount realised is after 1st April 2025 as per the Finance Act of 2024, prior to which the slab rate of the individual would be applicable.
Securities Transaction Tax
Securities Transaction Tax (STT) is a separate tax apart from the dividend tax and the capital gains tax. This is applied when there is a purchase or sale of any security listed in the stock market, including that of mutual funds. The STT rate is different for the sale or purchase of shares or stock, whereas the STT is only applicable to transactions of equity-oriented funds. The rate of STT applied is 0.001% as provided under Section 98 of the Securities Transaction Tax Chapter of Finance Act of 2004. Debt mutual funds do not fall under the ambit of this provision which implies there is no STT applied on them.
TDS
Tax Deduction at Source (TDS) provisions help in the collection of the tax at the source before the money has been received by the person. These help in the robust collection of taxes and can be claimed back in case there has been an excess deduction at the time of filing of the Income Tax Returns. The TDS was applicable to the repurchase of mutual funds where a 20% TDS deduction was mandated under Section 194F of the Income Tax Act 1961. The main aim of this provision was to ensure the individuals who did not realise the amount from the mutual fund would also have to pay tax. However, this provision has been abolished in the Finance Act of 2024, with effect from 1st October 2024.
Another provision of TDS is Section 194K of the Income Tax Act 1961 (Section 393 of the Income Tax Bill 2025) where the dividend distributed exceeding Rs. 5000 would be subject to a TDS deduction of 10% by the AMCs, as discussed before. However, Section 194K, introduced in the Finance Act of 2021 does not mandate any TDS on the capital gains arising from the redemption of the mutual fund units. The maximum TDS rate of 20% would be applicable if the unit holder has not provided the PAN number.
Exit Load
Exit load is not a tax, but a charge levied on the Mutual Fund holder when a holder withdraws the amount in a short duration of time. This is levied on the withdrawals which are mostly done prior to 1 year, and is calculated as a percentage of the NAV, ranging from 0.5% to 2%. This fee is levied by the AMC to ensure that the mutual fund holder does not withdraw quickly avoiding volatility in the fund, while also ensuring that the investment is carried out for a long term.
As the exit load is a charge levied as a percentage of the NAV, the additional revenue generated by the AMC through exit load is charged at 18% under the GST Acts, as this falls under the heading “consideration for services” as provided under the Central Tax (Rate) – Notification No. 11/2017. This 18% is levied on the exit load collected by the AMC. For example, if the exit load of 1% is deducted from the investment of Rs. 1 lakh, and Rs. 1000 is deducted before the investment is sent to the investor, then 18% would be applicable on Rs. 1000, which is Rs. 180, which needs to be remitted to the government. However, the exit load collected is not considered part of the business income as this is subjected to tax under GST.
AMCs can also impose switching charges for switching between funds within the same AMC. For example, the AMC State Bank of India manages multiple mutual funds, including the SBI Long Term Equity Fund, SBI Magnum Gilt Fund, and SBI Gold Fund, all of which form part of the same AMC. When an individual shifts from one of these funds to another, the unit holder might be charged for switching. These charges are usually not levied.
However, when a unit holder switches from one mutual fund to another, no charges levied, however, the standard charges and taxes as discussed above for the realisation of the mutual fund might be applied depending on the type of mutual fund.
CONCLUSION
Understanding all these taxes and charges on mutual fund transactions is essential as these transactions are carried out by wide number of investors. These various charges and taxes not only help in making informed decisions prior to investing in a mutual fund, but they also provide a clear understanding of how much of the mutual fund is not actually received by the investor. Although we see the major charges imposed on the transactions, not many notice the various taxes imposed on these charges which are a crucial part of the functioning of the Mutual Funds. This information not only helps in efficient decision-making but also helps us understand the various costs of this efficient, convenient, and popular investment method.
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