NISM Series V-D · Chapter 8: Taxation

L1 · Foundation

Foundation — Who pays tax, on what, and the six things that change the rate

Why the fund itself pays no tax, what an investor is actually taxed on, the six variables that decide the rate, the holding periods that split short term from long term, grandfathering at 31 January 2018 and the Rs 1.25 lakh exemption.

14 min read · Worth 2% of the paper · Written from pages 161–171 of the official NISM workbook · Updated 18 September 2026

Start here: tax is not a detail, it is the return

"When anyone considers making an investment, one of the objectives is to get some investment returns. However, such returns... may be subject to tax. The investor would get the income after the payment of taxes."

And the line every distributor should carry into a client meeting: "It is not how much you earn, but how much you KEEP AFTER TAXES that counts."

"As a mutual fund is a PASS-THROUGH VEHICLE, we must consider the income at TWO LEVELS – income earned by the fund, and income earned by the investor."

8.1.2 Level one — the fund pays nothing

"The schemes of the mutual funds invest in marketable securities like shares and debentures. These securities generate income in the form of dividend or interest. Apart from this, when the fund buys and sells the shares and debentures..., there could be capital gains or losses. Interest, dividend and capital gains form the income of the mutual fund."

Then the crucial exemption: "As per the prevailing tax laws in India, a mutual fund's income is EXEMPT FROM INCOME TAX, since mutual funds are constituted as TRUSTS in India for the benefits of the unitholders. SECTION 10(23)(D) of the Income Tax Act EXEMPTS ALL THE INCOME earned by the mutual fund schemes from any tax."

This is the single most examined fact in the chapter, and it has a practical consequence worth stating: a fund manager can sell a holding and buy another without any tax leaking out of the scheme. The investor's tax event happens only when the investor sells.

8.1.3 Level two — the investor

"the investor can choose from two options within the scheme, viz. (earlier called Dividend) Income Distribution cum Capital Withdrawal (IDCW) option and growth. The one who has opted for IDCW may get income in form of dividends, whereas the investor in the growth plan would NOT get any dividend WHATSOEVER, IRRESPECTIVE OF THE PROFITS EARNED BY THE FUND."

"The investor in the growth plan would earn capital gains (or losses) whenever one SELLS the units. On the other hand, the investor in the IDCW plan may get dividend, as and when declared by the fund, AS WELL AS capital gains (or losses) when one sells the units."

The six variables that decide the rate

"The tax rates would vary as under:"

1. Type of income. "The capital gains are taxed differently in comparison to the dividend income (IDCW)."

2. Holding period. "Capital gains may be categorized as short term and long term based on the holding period. At the same time, within capital gains, short term capital gains may attract different tax rates in comparison to long term capital gains."

3. Type of mutual fund scheme. "The Income Tax Act defines TWO CATEGORIES of mutual funds, viz., equity-oriented funds and non-equity-oriented funds. The schemes holding MORE THAN 65 PERCENT of the assets under management in EQUITY SHARES LISTED ON RECOGNISED STOCK EXCHANGES IN INDIA are classified as equity-oriented mutual fund schemes. All the other schemes are classified as non-equity-oriented schemes."

And a trap the workbook plants deliberately: "For example, FUND-OF-FUNDS investing in OTHER EQUITY MUTUAL FUND SCHEMES, would be classified as NON-EQUITY-ORIENTED schemes. Though the said scheme is eventually investing in equity assets (equity mutual funds), it is classified as a NON-EQUITY-ORIENTED scheme for the purpose of income tax." A fund of funds holds units, not listed equity shares — so it fails the test.

4. Type of investor. "The tax treatment may differ for Resident Indian Investors, NRIs, and non-individual investors. It must be noted that in case of JOINT HOLDING, the income, be it capital gains or dividend, would be considered to have been earned by the FIRST HOLDER."

5. Date of purchase. "The union budget 2023 brought some changes in the taxation of capital gains... applicable from April 1, 2023 onwards. Investments made PRIOR to that date... would enjoy the OLD tax structure."

6. Date of redemption. "Union budget for the year 2024-25... presented in the parliament in July 2024... To achieve the objective of simplification of taxes, this budget brought about many changes, primarily the tax on capital gains. The new tax rules became effective immediately. However, if the units are redeemed BEFORE JULY 23, 2024, the OLD tax rates would apply. The NEW tax rates would be applicable for units redeemed ON OR AFTER JULY 23, 2024."

Note the neat division of labour between variables 5 and 6: one turns on when you bought, the other on when you sold.

8.2 Capital gains — the two holding periods

"When a unitholder sells units of the scheme, the selling price could be different from the price at which the units were bought. The difference... would be treated as capital gain (or loss). If the selling price is higher... there is an incidence of capital gain, whereas if the selling price is lower... there is a capital loss."

"Capital gains are classified into two categories: short term capital gains and long-term capital gains. For classifying assets into long-term and short-term, there will only be TWO HOLDING PERIODS: 12 MONTHS AND 24 MONTHS. The holding period for ALL LISTED SECURITIES as well as for UNITS OF EQUITY-ORIENTED FUNDS is 12 MONTHS. The holding period for ALL OTHER ASSETS is 24 MONTHS."

Two numbers, and only two. The 36-month period that older material refers to is gone.

Grandfathering — 31 January 2018

"Equity mutual funds were exempt from long term capital gains tax earlier. In the Union Budget of the year 2018, this was changed. The long-term capital gains became taxable."

"Since the capital gains from equity assets were non-taxable till the announcement of the budget in 2018, an introduction of the tax would have meant that even the gains earned till then would also become taxable. This is equivalent to introducing tax with RETROSPECTIVE EFFECT. In order to avoid such a situation, the finance minister introduced a clause, which came to be known as the 'GRANDFATHERING of the capital gains'."

The rule: "the capital gains earned till JANUARY 31, 2018 would NOT be taxable, which means that for all the equity mutual funds that one has invested in, the valuation as on January 31, 2018 becomes the BASE POINT. Gains would be calculated for the purpose of tax by taking the HIGHER OF THE PURCHASE PRICE OR THE NAV AS ON JANUARY 31, 2018. The grandfathering benefit was offered in order to ensure that the effect of the tax is only on a PROSPECTIVE basis and not retrospective."

The workbook's two scenarios use an investment of Rs 1,00,000 made in 2017, worth Rs 2,00,000 on 31 January 2018:

Scenario 1. "If the investor sells the investments completely and realises a value of Rs 1,80,000 on February 9, 2018 then the long-term capital gains for the purpose of taxes would be considered to be ZERO, since the realised value is less than the value of investments on January 31, 2018."

Scenario 2. "If the investor sells... and realises a value of Rs 2,20,000; the long-term capital gains for the purpose of taxation would be considered to be Rs 20,000 (the difference between the realised value of Rs 2,20,000 and the value on January 31, 2018 – Rs 2,00,000)."

Notice what grandfathering does not do. It does not create a loss. In Scenario 1 the taxable gain is zero, not a deductible loss of Rs 20,000, even though the actual money made was Rs 80,000.

The Rs 1.25 lakh exemption

"In case of long-term capital gains arising out of EQUITY SHARES AND EQUITY-ORIENTED MUTUAL FUNDS, the tax is applicable only on the capital gains ABOVE Rs 1.25 LAKHS. The FIRST Rs 1.25 LAKHS worth of long-term capital gain from this category is TAX-EXEMPT."

"For example, if an investor has earned a total long term capital gain worth Rs 90,000 in a year, the entire capital gain would be exempt from tax. On the other hand, if the total capital gain is Rs 1,35,000; the first Rs 1,25,000 would be exempt... but the next Rs 10,000 would be subject to tax."

The tax table — Tax Regulations for Unit Holders

Investment asset	STCG	LTCG	Holding period
Equity-oriented funds (including hybrid funds with more than 65% in equity)	20%	12.50%	LTCG applicable after 12 months. Exemption Rs 1.25 lakh per financial year
Debt-oriented funds (including hybrid funds with more than 65% in debt)	Marginal Slab Rate (MSR)	Marginal Slab Rate (MSR)	—
Hybrid mutual funds with 35% to 65% in domestic equities	MSR	12.50%	LTCG applicable after 24 months
Other MFs (Fund of Funds, International Funds / FOFs)	MSR	12.50%	LTCG applicable after 24 months
Equity ETFs	MSR	12.50%	LTCG applicable after 12 months
Gold ETFs	MSR	12.50%	LTCG applicable after 12 months
Debt ETFs	Marginal Slab Rate (MSR)	Marginal Slab Rate (MSR)	—

Read the table row by row rather than trying to find a pattern. The equity-oriented fund row is the only one with 20% STCG; everything else short-term is at the investor's marginal slab rate. Debt-oriented funds and debt ETFs have no long-term concession at all — MSR both ways, regardless of how long they are held.

Think of it like this

The fund is a pipe, not a tank

Water flowing through a pipe does not belong to the pipe. "As a mutual fund is a PASS-THROUGH VEHICLE, we must consider the income at two levels – income earned by the fund, and income earned by the investor." And at the first level nothing is taken: "a mutual fund's income is exempt from income tax, since mutual funds are constituted as trusts... Section 10(23)(D)... exempts all the income earned by the mutual fund schemes from any tax." This is why a fund manager can sell Infosys and buy TCS on the same day without a rupee of tax leaking out of your scheme — something you could never do in your own demat account.

A fund of funds holds units, not shares

The definition is mechanical, and that is the trap: a scheme is equity-oriented only if it holds "more than 65 percent of the assets under management in EQUITY SHARES LISTED ON RECOGNISED STOCK EXCHANGES IN INDIA." A fund of funds investing in equity mutual funds holds units of schemes, not listed shares — so "though the said scheme is eventually investing in equity assets... it is classified as a NON-EQUITY-ORIENTED scheme." Like a man holding a receipt for gold in a vault: economically he owns gold, but if the rule says "gold in your possession", the receipt does not qualify. Read the definition, not the economics.

Two clocks, twelve and twenty-four

The whole of capital gains classification now runs on two numbers: "there will only be TWO HOLDING PERIODS: 12 MONTHS AND 24 MONTHS. The holding period for all listed securities as well as for units of equity-oriented funds is 12 months. The holding period for all other assets is 24 months." Older material talks about 36 months; ignore it. Think of it as two train timetables — the fast line at 12 months for listed securities and equity-oriented funds, and the slow line at 24 months for everything else. Miss your train and you are taxed as short term.

Grandfathering is a floor, not a subsidy

Grandfathering resets your cost to "the higher of the purchase price or the NAV as on January 31, 2018." In Scenario 1 an investment of Rs 1,00,000 worth Rs 2,00,000 on that date is sold for Rs 1,80,000 — and the taxable gain is zero, not a loss of Rs 20,000. In Scenario 2, selling at Rs 2,20,000 gives a taxable gain of exactly Rs 20,000, not Rs 1,20,000. It is like a shopkeeper agreeing that your old stock is valued at last year's higher price for the purpose of the new levy — it protects you from the new tax reaching backwards, but it does not hand you a deduction. The purpose was narrow: "to ensure that the effect of the tax is only on a prospective basis and not retrospective."

The first Rs 1.25 lakh is free, the rest is not

The exemption is a slice, not a switch. "if an investor has earned a total long term capital gain worth Rs 90,000 in a year, the entire capital gain would be exempt. On the other hand, if the total capital gain is Rs 1,35,000; the first Rs 1,25,000 would be exempt... but the next Rs 10,000 would be subject to tax." Nobody loses the whole exemption by crossing the line — the excess alone is taxed. It works like the free baggage allowance at an airport: cross by two kilos and you pay for two kilos, not for the entire suitcase. And note that it is per financial year, and only for equity shares and equity-oriented mutual funds.

One row is different from all the others

Scan the tax table and one thing stands out: the equity-oriented funds row is the only row with an STCG rate of 20%. Every other short-term row — hybrid 35–65%, fund of funds, international funds, equity ETFs, gold ETFs, debt funds, debt ETFs — says Marginal Slab Rate. Meanwhile 12.50% LTCG appears in five rows, and debt-oriented funds and debt ETFs get no long-term concession at all, being at MSR whichever way you hold them. Do not look for a pattern that is not there; memorise the rows, and remember the two that are all-MSR.

Equity ETF is not an equity-oriented fund, for STCG

This one catches careful students. An equity ETF gets the 12-month holding period and 12.50% LTCG, just like an equity-oriented fund — but its STCG is at the marginal slab rate, not 20%. So two investors, one in a large-cap fund and one in a Nifty ETF, selling after nine months, can face completely different tax bills. The workbook lists Equity ETFs and Gold ETFs as their own rows for exactly this reason. When a question names an ETF, stop and check the row — do not answer from the equity fund row out of habit.

Who owns the income in a joint folio

Two names on a folio does not mean two taxpayers. "in case of JOINT HOLDING, the income, be it capital gains or dividend, would be considered to have been earned by the FIRST HOLDER." Families sometimes add a low-income spouse or parent as a joint holder hoping to split the gain — the rule simply does not work that way. The same principle appears again in Section 80C: "the tax benefit would be available to the first holder, in case of a joint holding." First holder takes the income and takes the deduction. Second holder takes neither.

Key terms in this chapter

Base expense ratio (from 1 April 2026): The sum of investment and advisory fees, out-of-pocket expenses and brokerage commission, excluding statutory levies on those expenses and excluding transaction cost. The investor's total is this plus brokerage cost, transaction cost, statutory levies and exit load — and nothing else.
Bonus stripping: Buying units shortly before a bonus record date and selling the original units at the halved NAV to book an artificial loss. If the units were bought within three months before the record date and sold within nine months after it, the loss cannot be set off and instead becomes the cost of acquisition of the bonus units.
Deferment of taxes: The advantage of the growth option — since the scheme itself is tax-exempt and capital gains are realised only when booked, gains compound before tax until the investor chooses to sell.
Dividend Distribution Tax (DDT): The tax deducted from the scheme before paying dividend under the old regime, abolished in the February 2020 budget with effect from April 2020. It was not a tax in the investor's hands and so could not be set off against any other liability.
Double Taxation Avoidance Agreement (DTAA): Agreements specifying withholding tax rates with several countries. For a non-resident investor the applicable TDS is the lower of the income tax regulation rate or the DTAA rate, and the investor must supply documents to establish the entitlement.
Equity Linked Savings Scheme (ELSS): An equity scheme eligible for deduction under Section 80C in the old tax regime, up to Rs 1.5 lakh a year for individuals and HUFs, with a three-year lock-in from the date of each investment.
Equity-oriented fund (for income tax): A scheme holding more than 65 per cent of assets under management in equity shares listed on recognised stock exchanges in India. Everything else is non-equity-oriented.
Grandfathering of capital gains: The rule protecting gains earned up to 31 January 2018 from the long-term capital gains tax introduced in the 2018 budget — cost is taken as the higher of the purchase price or the NAV on that date, so the tax operates prospectively rather than retrospectively.
GST treatment in a scheme: GST on investment management and advisory fees is charged to the scheme over and above the TER limits; GST on all other fees, and on brokerage and transaction costs, sits within the TER; GST on exit load is deducted from the exit load so only the net reaches the scheme; and GST on distributor commission is the ARN holder's liability and cannot be charged to the scheme.
Income Distribution cum Capital Withdrawal (IDCW): The renamed dividend option. Since April 2020 the payout is added to the investor's income and taxed at the marginal slab rate; from 1 April 2021 the fund must show how much of it is NAV appreciation and how much capital distribution.
Marginal Slab Rate (MSR): Taxation at the investor's own income tax slab rate. It applies to short-term gains on everything except equity-oriented funds, to both short and long term gains on debt-oriented funds and debt ETFs, and to IDCW income.
Pass-through vehicle: What a mutual fund is for tax purposes — income must be looked at "at two levels: income earned by the fund, and income earned by the investor". The fund level is exempt, so the tax event happens only when the investor sells or receives an IDCW.
Rs 1.25 lakh exemption: The first Rs 1.25 lakh of long-term capital gain in a financial year from equity shares and equity-oriented mutual funds is exempt; only the excess is taxed.
Section 10(23)(D): The provision of the Income Tax Act that exempts all income earned by mutual fund schemes from any tax, because mutual funds are constituted as trusts for the benefit of unitholders.
Securities Transaction Tax (STT): A levy on the sale side of equity-oriented mutual fund units, whether sold on an exchange or offered for repurchase to the fund. Never charged on purchase, and never on debt securities or debt schemes.
Set-off rules for capital losses: Capital loss of either kind cannot be set against any other head of income. Short-term loss may be set against short-term or long-term gains; long-term loss only against long-term gains; and unabsorbed loss carries forward up to eight years.
Shared 80C limit: The Rs 1.5 lakh ceiling covers all eligible avenues together. If the limit is exhausted elsewhere an ELSS investment earns no further deduction — but it is still locked in for three years.
SIP lock-in in ELSS: Each instalment is locked in for three years from its own date, so the lock-in on the whole amount does not end three years after the first instalment. Each reinvested dividend attracts a fresh three-year lock-in too.
Stamp duty on units: 0.005% of the amount invested on every purchase-side inflow since 1 July 2020 — lump sum, additional purchase, SIP, STP, DTP, switch-in and dividend reinvestment, for both SoA and demat units — and 0.015% on transfer of units. Units are allotted only for the amount remaining after the duty is deducted.
TDS on IDCW: Tax deducted at source at 10 per cent on dividend from mutual fund schemes exceeding Rs 10,000, applicable even to resident Indians — in contrast to repurchase proceeds to residents, on which there is no TDS.
Twelve and twenty-four months: The only two holding periods used to split short term from long term. Twelve months for all listed securities and units of equity-oriented funds; twenty-four months for all other assets.

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Original explanatory writing based on the official NISM workbook for Series V-D, which is published and copyrighted by NISM. Check figures against the current edition at nism.ac.in.

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