The profits that you earn from your mutual fund investments after selling your units is a form of income and hence will be taxed accordingly. Income earned by sale of mutual fund units come under the category of capital gains and you have to pay capital gains tax on the same.

Computation of mutual funds gains is fairly easy. It is nothing but the difference between the price of mutual fund units at the time of withdrawal (A) and the price of mutual fund units at the time of purchase (B). So, Capital Gains = A – B.

Let’s say you bought 1000 units of a mutual fund scheme at an NAV of ₹20. Then (B) becomes ₹20 x 1000. Now you sold these units when the NAV was ₹55 so (A) would be ₹55 x 1000.  So, Capital Gains would be ₹55,000 – ₹20,000 or ₹35,000.

Amount of tax applicable on such gains depend on the following factors:

• Mutual Fund Type
  For tax purposes mutual fund schemes are divided into two categories Equity Mutual Funds and Non Equity Funds.
  Mutual funds schemes that invest at least 65% of their portfolio in equity (shares issued by companies) or equity related instruments are called equity mutual funds.
  And those schemes which invest less than 65% of their portfolio in this manner are called non equity funds. Debt Funds, Gold Funds, International Funds, Fund of Funds etc. all come under the non-equity category while calculating tax.
• Holding Period
  Capital gains are of two types Long Term Capital Gains and Short Term Capital Gains. This bifurcation depends on the holding period of the investments. The time between your date of purchase and date of redemption is called holding period. Whether your holding period will be considered long term or short term depends on the type of mutual fund you invested in equity mutual funds, long term is 12 months or more. If you earn any profit by selling your equity fund units before 12 months it will be considered as short term capital gains.For non-equity funds long term is 36 months (3 years) or more. If you gain by selling your debt funds within 3 years of its purchase you are required to pay short term capital gain tax on those gains.In case of regular investments like SIP or STP each transaction is viewed as a fresh investment & holding period is calculated on first in first out basis. For example, you contributed to a SIP from January 2016 till August 2016 & decided to withdraw the entire investment in March 2017. Only the first two installments of January and February will be considered as long term, the other six will be considered short term.

Now, let’s fund out the amount of tax payable:

Equity Funds
Long Term Capital Gains Tax is NIL. That is, you don’t have to pay any tax on your gains if you sell your units after 12 months of purchase. (UPDATE: As of 1st April 2018 LTCG tax on equity oriented funds has been changed to 10% over gains of ₹1,00,000. For details click here) Short Term Capital Gain Tax is flat 15% on the amount of profits.

Non-Equity Funds
Short Term Capital Gains tax is as per your income slab. This means that all short term gains are added to your income and taxed accordingly i.e if you fall under 10% tax bracket you have to pay 10% tax on your capital gains if you fall under 30% tax bracket you pay 30% tax on such gains and so on.
Long Term Capital Gains Tax is calculated at 20% with indexation. Indexation gives the benefit of inflation to your purchase cost. The rate of inflation to be applied in indexation process is taken from the government Cost Inflation Index (CII). You can check the value of Cost Inflation Index here.

The formula used to arrive at the indexed cost of purchase is:

For example, say your purchase price was ₹50,000 when you bought units in November 2012 and you sold those units in February 2017 for ₹100,000. This would imply that you have to pay tax on your gain of ₹50,000. But with the help of indexation, the cost of purchase is which is ₹66,021. So, you have to pay tax on ₹100,000 – ₹66,021 i.e ₹33,979 instead of entire ₹50,000.

Apart from the above there is something called STT (Securities Transaction Tax) which is applicable on sale of any equity fund units (not applicable in case non-equity funds). This is levied at 0.001% i.e 1 paise for every ₹1000 sale.

The longer you stay invested in mutual funds more tax efficient your investment becomes. Be tax aware and make most out of your investments.