What is Short Term Capital Gain (STCG) Tax on Mutual Funds? (2024)

Whether you are a new or a seasoned mutual fund investor, there are multiple parameters that you generally look at before investing. Factors like the risk-return profile, cost of investing, etc are some of the common ones that investors generally consider. Another very important factor to consider is taxation. A post-tax return is your actual return. Taxes are unavoidable; therefore, you must consider the post-tax returns when investing in any instrument, including your mutual funds.

If you have invested in a mutual fund for a relatively shorter period, you will have to pay short-term capital gains tax.

Let’s understand in detail what short-term capital gains (STCG) are in the case of mutual funds.

Before we move on to describe a short-term capital gain tax on mutual funds, let us brush up on our fundamentals.
A mutual fund is a popular financial instrument that collects money from several investors, invests it in different assets, and provides returns to the investors as per market conditions. These returns are generally of two types — capital gains and dividends.

The following example will help you understand capital gains in a better way:

For example, you invested Rs. 3 lakhs in a mutual fund scheme in 2020. But in 2021, the value of this investment became Rs. 3.15 lakhs. Here, the difference of Rs. 15,000 is your capital gain.

In terms of taxation, the tax on mutual fund dividends is levied in the hands of the investor as per their income tax slabs. But capital gains are taxed at specified rates depending on the holding period of funds and the type of mutual fund scheme. A part of the capital gains tax called the short-term capital gains tax, we shall explain in detail in the subsequent sections. To know more on what is tax on mutual funds, please click here.

The Short Term Capital Gain Tax refers to the gains earned from investments made for shorter periods. For taxation purposes, the term ‘short-term’ is defined differently for different types of mutual funds. For example, for debt funds, STCG implies that the investment was held for less than 36 months. On the other hand, for equity funds, any investment held for less than 12 months will come under STCG, if redeemed.

As an investor, you can choose to invest in different types of mutual funds, like debt funds, equity funds, and hybrid funds. On holding these investments for less than 12 months (36 months in some cases), the gains from the transfer of these funds will be considered STCG on mutual funds. Below is the summary of the STCG on the basis of holding period for various types of mutual funds-

As the name suggests, short term capital gains tax refers to the tax levied on STCG. The taxability of STCG on mutual funds depends on the type of mutual funds and the holding period.

For taxation purposes, any mutual fund investing less than 65% in Indian equity and related instruments will get the tax treatment of debt funds.

The STCG on debt mutual funds is earned on sale or transfer of fund units held for less than 36 months. STCG on debt mutual funds are taxed as per the investor’s tax slab rate. In other words, these gains are added to the investor’s taxable income and taxed accordingly. For example, if an investor is in highest tax bracket, gains will be taxed at 30%.

If you are interested to know more on debt funds and indexation, thenclick here.

Hybrid mutual funds help the investors in attaining diversity in their investment portfolio. They invest in a mixture of debt and equity-oriented instruments. An individual can choose to invest in different types of hybrid funds, including equity-oriented hybrid funds, balanced funds, and debt-oriented hybrid funds. The STCG tax rate on mutual funds falling into this category varies depending on the holding periods and their respective orientation.

The following table covers the short-term capital gains tax on various types of hybrid funds:

The STCG taxation rate on hybrid funds also depends on the portfolio’s equity exposure. For instance, a mutual fund scheme in which equity exposure goes beyond 65% is taxed like an equity fund. Otherwise, the taxation rules of debt funds are applicable. As an investor, you must know about the equity exposure of hybrid mutual funds you choose to invest in.

Here’s a quick summary of STCG tax on mutual funds:

Many individuals prefer investing in mutual funds through Systematic Investment Plans, also known as SIPs. This investment method allows them to periodically invest a small amount in a mutual fund scheme of their choice.

When you invest in thebest SIP mutual funds, you buy a certain number of units with every SIP payment. The redemption of these mutual fund units follows the first-in-first-out principle. You can better understand this with the following example –

You invested in hybrid equity-oriented funds through SIP for a year and then decided to redeem the invested amount after 13 months. Here, the units purchased in the first month of your SIP investment are held for more than a year, thus making you realise long-term capital gains on them.

On the other hand, you make STCG on mutual fund units purchased from the second month onwards. The STCG tax rate on mutual fund units here will be 15% along with the applicable cess and surcharge, irrespective of your income tax slab.

Apart from the short term capital gains tax on mutual funds, you will be charged another tax on buying or selling equity mutual funds — both equity funds or hybrid equity-oriented funds. It is known as Securities Transaction Tax or STT.

STT is levied by the Government of India at source on sale or purchase of equity mutual fund units at the rate of 0.001%. No STT is charged in relation to debt fund units transfer or sale.

Mr. Sugandh purchased 150 units of XX Mutual Fund – an equity-oriented mutual fund, at the rate of Rs. 100 per unit in November 2020. He then decided to sell these units in July 2021 at the rate of Rs. 130 per unit. In this case, the holding period for these mutual funds is less than 12 months.

Hence, the gain will be considered as short term capital gain on mutual funds. The tax is applicable on these gains as per Section 111A of the Income Tax Act. The STCG tax will be charged at the rate of 15% plus surcharge and cess.