How equity funds are taxed

When you sell units of an equity mutual fund for more than you paid, the profit is a capital gain, and it is taxed. How it is taxed depends on one thing above all: how long you held the units before selling. That holding period splits the gain into short-term and long-term, and the two are treated under different rules. This explains the mechanism; it quotes no rate as fixed, because the rates and thresholds are set by the law of the day and change.

When the tax event happens

An equity fund is not taxed year by year while you hold it. The tax event happens only when you redeem — sell units — or switch out of the scheme, which counts as a sale. Until then, gains are unrealised and untaxed, which is part of why the Growth option can compound efficiently. A IDCW payout is the exception: it is taxed when received, as income.

The holding period splits the gain

For an equity fund, the rules use a holding-period threshold to divide gains into two kinds. Sell before the threshold and the gain is a short-term capital gain; sell after it and the gain is a long-term capital gain. The exact threshold for equity funds is set by the rules and has been one year for some time, but the principle to carry — not any specific figure — is that longer holding moves you into the long-term category.

Short-term gains

A short-term capital gain on an equity fund — selling before the holding- period threshold — is taxed at its own flat rate set for equity, rather than at your income-slab rate. The rate itself is set by the rules of the day, so the point to take is the structure: sell early and a distinct short-term rate applies.

Long-term gains

A long-term capital gain on an equity fund is taxed at its own concessional rate, and the rules also provide an annual amount of long-term gains that is exempt before the tax applies. Both the rate and that exempt amount are set by the law and can change at a budget, so this article deliberately states the mechanism — a concessional long-term rate above an annual exemption — rather than a number that would go stale.

Why your records matter

Because the tax depends on when each unit was bought and sold, and an SIP buys units on many dates, working out a gain means matching each redemption to the instalments it came from. The fund and its registrar provide a capital-gains statement that does this for you, which is what your tax return draws on.