Short-Term Capital Gains Tax on Mutual Funds

When you redeem or sell a mutual fund investment, your profits are known as capital gains. Based on the holding period of the investment, capital gains can be divided into two types – Long-term capital gains (LTCG) and short-term capital gains (STCG). LTCG and STCG are taxed differently depending on the type of fund you have invested in. Mainly, the taxation rules for capital gains on mutual funds are categorised based on whether the fund is equity-oriented or specified (like debt, gold, etc.).

In this article, we’ll discuss all you need to know about mutual fund short term capital gain tax, from its definition, tax rates, calculation method, and strategies to minimise it.

What is Short-Term Capital Gains (STCG)?

Upon selling a capital asset such as mutual fund units, stocks, or property, any profit earned is categorised as capital gains. Short-term capital gain, or STCG, depends on how long the investment was held before being sold. There’s no uniformity across different asset classes when it comes to defining the holding period for STCG. 

The classification thus varies from asset to asset. For example, when selling real estate, STCG arises when the property is held for at least 24 months before being sold for profit. On the other hand, the profit from an equity mutual fund investment will be considered STCG only if it is sold within 12 months of purchase.

As you can see, the definition of short-term capital gains differs based on the type of asset, which is why you should be aware of the specific holding period. Generally, the short term capital gain tax on mutual fund investments and other capital assets is levied at a higher rate compared to LTCG tax.

What is the Current Tax Rule for STCG?

The mutual fund short term capital gain tax depends on the category of fund:

1. Equity-oriented Mutual Funds

According to SEBI (Securities and Exchange Board of India), equity mutual funds must invest at least 65% of their total assets in shares of domestic companies. These funds enjoy different, more favourable tax treatment of capital gains compared to other types of funds. Such funds are suitable for aggressive investors investing for the long term. Some examples of equity-oriented funds are large-cap funds, flexi-cap funds, ELSS, and sectoral funds.

Profits from equity-oriented funds are considered STCG when the investment is sold or redeemed within 12 months of purchase. Gains above that holding period are deemed LTCG. During the 2024 Union Budget, the Finance Minister announced major changes to the capital gains tax structure. The tax rate on short-term capital gains from equity-oriented mutual funds has been increased from 15% to 20%. 

This provision can be found under Section 111A of the Income Tax Act. However, if you sold your equity fund investment before 23rd July 2024, the old LTCG and STCG tax rates will apply. You can conveniently connect with an online tax advisor to understand the tax implications of your SIPs.

2. Debt Mutual Funds

This category of mutual funds includes schemes that invest over 65% of their portfolio in debt or money market instruments, like liquid and gilt funds. Finance Act 2023 essentially eliminated the holding period distinction for debt mutual funds. According to the Act, any investments made in debt funds after 1st April 2023 are taxed at the investor’s income tax slab rate without indexation benefit. 

That means any investments from here on will be treated as short-term capital gains, irrespective of how long they are held. The story is a little different if you look at debt fund investments made before 1st April 2023. Check out these two scenarios:

1. Investment made before 1st April 2023 and sold before 23rd July 2024:

Gains are considered STCG if the investment was sold after being held for 36 months. STCG tax is charged at the investor’s income tax slab rate.

2. Investment made before 1st April 2023 and sold on or after 23rd July 2024:

If the investment is held for 24 months or less, the profits are classified as short-term capital gains and taxed at the investor’s applicable tax slab rate.

How to Calculate Short-Term Capital Gains?

Follow these simple steps to calculate your STCG tax on mutual fund investments:

1. Subtract the purchase price from the sale price. This will give you the STCG amount.
2. Deduct Securities Transaction Tax.
3. This determines the taxable STCG amount. You can now apply the applicable rates.
4. For example, if you sold an equity fund investment, STCG will be levied at 20%. Suppose you made Rs. 1 lakh in STCG, you’d need to pay Rs. 20,000 as STCG tax, plus cess and surcharge.
5. Similarly, if you need to calculate the STCG tax liability on debt fund investments, you can use the above rules. For instance, for an investment you purchased after 1st April 2023 and sold on 1st March 2025, STCG tax will be levied as the long-term capital gains classification for such investments does not exist anymore. If you made a Rs. 1 lakh gain, you’ll be taxed according to your slab rate.
6. Cess and surcharge must be added to the final liability if applicable.
7. You can employ our tax advisory services to save more on capital gains. Our experts will create personalised tax plans to ensure you keep as much of your hard-earned money as possible.

Short-Term Capital Gains Tax for FY 2024-25

The rates for short term capital gain on mutual fund investments are given below:

For Equity-oriented funds: STCG tax is levied at 20%. If the investment was sold before 23rd July 2024, STCG will attract a lower tax rate of 15%.

For Specified mutual funds:

• STCG on investments after 1st April 2023 are taxed as per the investor’s slab rate. 
• Gains from investments made before 1st April 2023 and sold before 23rd July 2024 are considered STCG if the investment was held for less than 36 months before being sold, and taxed according to the slab rate.
• Profits on investments made before 1st April 2023 but sold after 23rd July 2024 are considered short-term capital gains when sold within 24 months of purchase. They are also subject to the investor’s slab rate.

Current Holding Period Rules for Short-Term Capital Gains (STCG)

Different categories of mutual funds have their own definition of STCG based on the investment’s holding period. Here’s how it works:

Equity-oriented funds: Profits are considered STCG if the investment is held for 12 months or less. Above that period, gains are considered LTCG.

Specified mutual funds: For these investments, the holding periods and STCG definition vary based on when the investment was made and sold.

• Investment made after 1st April 2023: No holding period. All capital gains are taxed the same – at the investor’s slab rate.
• Investments made before 1st April 2023 and sold before 23rd July 2024: Profits are deemed STCG if the investment was sold within 36 months of purchase.
• Investments made before 1st April 2023 but sold after 23rd July 2024: Gains are considered STCG if the investment was sold within 24 months of purchase.

LTCG and STCG Rates in 2023-24 and 2024-25 – A Comparison Table

Here’s a summary of long and short term capital gains tax mutual funds:

For Equity-oriented Mutual Funds

For Specified Mutual Funds

Short-Term Capital Gain Tax on Mutual Funds

As you can see from the table, the STCG tax is levied at higher rates compared to the LTCG tax for equity-oriented funds. The fact that there are no tax exemptions available for STCG earned from mutual funds makes short-term investing less tax-efficient than long-term. This is one reason why a mutual fund investment planner would likely recommend holding equity mutual fund investments for at least one year to qualify for the lower 12.5% LTCG tax rate (above Rs. 1.25 lakh in gains per year) instead of incurring the 20% STCG tax on profits made within a year. Still, that does not mean you should invest in riskier funds solely to achieve long-term tax benefits. Your investment decisions should prioritise your financial goals, risk tolerance, and investment horizon, rather than just the tax implications of your investment.

STCG Rates, Holding Period on Various Mutual Fund Schemes

The STCG tax rate on mutual fund investments belonging to the hybrid category depends on the asset allocation of the specific fund. For example, hybrid funds such as equity savings schemes invest only 30% to 40% in direct equities but also allocate a significant portion to arbitrage options. Since arbitrage counts as an equity-related instrument, the equity exposure of ESS goes above 65%. That’s why these funds qualify for equity-like taxation.

Short-Term Capital Gain Tax on Equity and Non-Equity Assets

We’ve seen how the mutual fund short term capital gain tax system works. Here’s how it’s levied on other equity and non-equity assets:

STCG tax on stocks: If listed equity shares are sold within 12 months of purchase, short-term gains are taxed at a rate of 20% under Section 111A of the Income Tax Act. For gains from unlisted shares to qualify as STCG, they must be held for less than 24 months instead of 12.

STCG tax on property: If a property is sold within 24 months of purchase, the profit is treated as short-term capital gain and is added to the seller’s total income and taxed accordingly.

Exemption on Short-Term Capital Gains

Unlike LTCG from equity-oriented funds, which benefit from an exemption of up to Rs. 1.25 lakh in a financial year, no exemption is available for STCG from mutual funds. However, there are some exemptions available on STCG from selling properties. These benefits are given in the Income Tax Act. For example,

• Section 54B: One can claim exemptions on gains from the sale of agricultural land, given that the profits are reinvested in land for agricultural use.
• Section 54D: Exemptions are available on gains from the compulsory acquisition of land or buildings used in an industrial undertaking by the government.

Tips for Reducing Taxes on Short-Term Capital Gains

Since no exemptions or benefits are available on short-term capital gains, investors can find it hard to reduce taxes. One can use the tax loss harvesting method if applicable, to good effect as short-term capital losses can be adjusted against both short-term and long-term capital gains. A financial consultant can help you plan your investments strategically to minimise taxes. 

But holding equity investments for longer can also allow you to enjoy a lower rate and Rs. 1.25 lakh exemption on LTCG every year. Tax harvesting, and choosing tax-efficient mutual funds like ELSS are also some ways to lower your tax burden.

Why is Understanding STCG Important?

Understanding how mutual fund short term capital gain tax works can help you lower your tax burden. You can accurately calculate taxes and returns, comply with regulations, and avoid paying any more taxes than necessary. This knowledge also helps you make better decisions about when to redeem your investment. Since staying invested for longer is more tax efficient, you can carefully assess your investment strategy and weigh whether your financial goals and situation align with a longer holding period for better tax benefits and returns.

Conclusion

Due to the recent changes in capital gains taxation, investors should carefully assess and optimise their investment strategies. As far as equity mutual fund short term capital gain tax is concerned, benefits like lower tax rate and Rs. 1.25 lakh LTCG exemption make long-term investing more tax-efficient. For specified mutual funds, STCG taxation depends on when the investment was bought and sold. 

In any case, STCG is levied at the investor’s applicable slab rate for debt-oriented funds and 20% (or 15% if sold before 23rd July 2024) for equity-oriented funds. Investors, especially those in the higher tax brackets have been negatively impacted. Understanding rules well and taking advantage of all eligible deductions and exemptions can help investors keep their tax liability in check.