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As per SEBI guidelines on Categorization and Rationalization of schemes issued in October 2017, mutual fund schemes are classified as –

1. Equity Schemes
2. Debt Schemes
3. Hybrid Schemes
4. Solution Oriented Schemes – For Retirement and Children
5. Other Schemes – Index Funds & ETFs and Fund of Funds

• – Under Equity category, Large, Mid and Small cap stocks have now been defined.
• – Naming convention of the schemes, especially debt schemes, as per the risk level of underlying portfolio (e.g., the erstwhile ‘Credit Opportunity Fund’ is now called “Credit Risk Fund”)
• – Balanced / Hybrid funds are further categorised into conservative hybrid fund, balanced hybrid fund and aggressive hybrid fund.

1. Equity Schemes

An equity Scheme is a fund that –

• Primarily invests in equities and equity related instruments.
• Seeks long term growth but could be volatile in the short term.
• Suitable for investors with higher risk appetite and longer investment horizon.

The objective of an equity fund is generally to seek long-term capital appreciation. Equity funds may focus on certain sectors of the market or may have a specific investment style, such as investing in value or growth stocks.

Equity Fund Categories as per SEBI guidelines on Categorization and Rationalization of schemes

*Also referred to as Diversified Equity Funds – as they invest across stocks of different sectors and segments of the market. Diversification minimizes the risk of high exposure to a few stocks, sectors or segment.

Sector Specific Funds

Sectoral funds invest in a particular sector of the economy such as infrastructure, banking, technology or pharmaceuticals etc.

• Since these funds focus on just one sector of the economy, they limit diversification, and are thus riskier.
• Timing of investment into such funds are important, because the performance of the sectors tend to be cyclical.

Examples of Sector Specific Funds - Equity Mutual Funds with an investment objective to invest in

• Pharma & Healthcare Sector
• Banking & Finance Sector:
• FMCG (fast moving consumer goods) and related sectors.
• Technology and related sectors

Thematic Funds

• Thematic funds select stocks of companies in industries that belong to a particular theme - For example, Infrastructure, Service industries, PSUs or MNCs.
• They are more diversified than Sectoral Funds and hence have lower risk than Sectoral funds.

Value Funds (Strategy And Style Based Funds)

• Equity funds may be categorized based on the valuation parameters adopted in stock selection, such as
  – Growth funds identify momentum stocks that are expected to perform better than the market
  – Value funds identify stocks that are currently undervalued but are expected to perform well over time as the value is unlocked
• Equity funds may hold a concentrated portfolio to benefit from stock selection.
  – These funds will have a higher risk since the effect of a wrong selection can be substantial on the portfolio’s return

Contra Funds

• Contra funds are equity mutual funds that take a contrarian view on the market.
• Underperforming stocks and sectors are picked at low price points with a view that they will perform in the long run.
• The portfolios of contra funds have defensive and beaten down stocks that have given negative returns during bear markets.
• These funds carry the risk of getting calls wrong as catching a trend before the herd is not possible in every market cycle and these funds typically underperform in a bull market.
• As per the SEBI guidelines on Scheme categorisation of mutual funds, a fund house can either offer a Contra Fund or a Value Fund, not both.

Equity Linked Savings Scheme (ELSS)

ELSS invests at least 80% in stocks in accordance with Equity Linked Saving Scheme, 2005, notified by Ministry of Finance.

• Has lock-in period of 3 years (which is shortest amongst all other tax saving options)
• Currently eligible for deduction under Sec 80C of the Income Tax Act upto ₹1,50,000

Debt Schemes

• A debt fund (also known as income fund) is a fund that invests primarily in bonds or other debt securities.
• Debt funds invest in short and long-term securities issued by government, public financial institutions, companies
  – Treasury bills, Government Securities, Debentures, Commercial paper, Certificates of Deposit and others
• Debt funds can be categorized based on the tenor of the securities held in the portfolio and/or on the basis of the issuers of the securities or their fund management strategies, such as
  – Short-term funds, Medium-term funds, Long-term funds
  – Gilt fund, Treasury fund, Corporate bond fund, Infrastructure debt fund
• Floating rate funds, Dynamic Bond funds, Fixed Maturity Plans
• Debt funds have potential for income generation and capital preservation.

Debt Fund Categories as per SEBI guidelines on Categorization and Rationalization of schemes

Dynamic Bond funds alter the tenor of the securities in the portfolio in line with expectation on interest rates. The tenor is increased if interest rates are expected to go down and vice versa

Floating rate funds invest in bonds whose interest are reset periodically so that the fund earns coupon income that is in line with current rates in the market, and eliminates interest rate risk to a large extent

Short-Term Debt Funds
The primary focus of short-term debt funds is coupon income. Short term debt funds have to also be evaluated for the credit risk they may take to earn higher coupon income. The tenor of the securities will define the return and risk of the fund.

– Funds holding securities with lower tenors have lower risk and lower return.

• Liquid funds invest in securities with not more than 91 days to maturity.
• Ultra Short-Term Debt Funds hold a portfolio with a slightly higher tenor to earn higher coupon income.

Short-Term Fund combine coupon income earned from a pre-dominantly short-term debt portfolio with some exposure to longer term securities to benefit from appreciation in price.

Fixed Maturity Plans (FMPs)
– FMPs are closed-ended funds which eliminate interest rate risk and lock-in a yield by investing only in securities whose maturity matches the maturity of the fund.
– FMPs create an investment portfolio whose maturity profile match that of the FMP tenor.
– Potential to provide better returns than liquid funds and Ultra Short Term Funds since investments are locked in
– Low mark to market risk as investments are liquidated at maturity.
– Investors commit money for a fixed period.
– Investors cannot prematurely redeem the units from the fund
– FMPs, being closed-end schemes are mandatorily listed - investors can buy or sell units of FMPs only on the stock exchange after the NFO.
– Only Units held in dematerialized mode can be traded; therefore investors seeking liquidity in such schemes need to have a demat account.


Capital Protection Oriented Funds
Capital Protection Oriented Funds are close-ended hybrid funds that create a portfolio of debt instruments and equity derivatives
– The portfolio is structured to provide capital protection and is rated by a credit rating agency on its ability to do so. The rating is reviewed every quarter.
– The debt component of the portfolio has to be invested in instruments with the highest investment grade rating.
– A portion of the amount brought in by the investors is invested in debt instruments that is expected to mature to the par value of the capital invested by investors into the fund. The capital is thus protected.
– The remaining portion of the funds is used to invest in equity derivatives to generate higher returns

HYBRID FUNDS

Hybrid funds Invest in a mix of equities and debt securities.

SEBI has classified Hybrid funds into 7 sub-categories as follows:

Solution-oriented & Other funds

Hybrid funds
Invest in a mix of equities and debt securities. They seek to find a ‘balance’ between growth and income by investing in both equity and debt.
– The regular income earned from the debt instruments provide greater stability to the returns from such funds.
– The proportion of equity and debt that will be held in the portfolio is indicated in the Scheme Information Document
– Equity oriented hybrid funds (Aggressive Hybrid Funds) are ideal for investors looking for growth in their investment with some stability.
– Debt-oriented hybrid funds (Conservative Hybrid Fund) are suitable for conservative investors looking for a boost in returns with a small exposure to equity.
– The risk and return of the fund will depend upon the equity exposure taken by the portfolio - Higher the allocation to equity, greater is the risk

Multi Asset Funds

• A multi-asset fund offers exposure to a broad number of asset classes, often offering a level of diversification typically associated with institutional investing.
• Multi-asset funds may invest in a number of traditional equity and fixed income strategies, index-tracking funds, financial derivatives as well as commodity like gold.
• This diversity allows portfolio managers to potentially balance risk with reward and deliver steady, long-term returns for investors, particularly in volatile markets.

Arbitrage Funds
“Arbitrage” is the simultaneous purchase and sale of an asset to take advantage of the price differential in the two markets and profit from price difference of the asset on different markets or in different forms.
– Arbitrage fund buys a stock in the cash market and simultaneously sells it in the Futures market at a higher price to generate returns from the difference in the price of the security in the two markets.
– The fund takes equal but opposite positions in both the markets, thereby locking in the difference.
– The positions have to be held until expiry of the derivative cycle and both positions need to be closed at the same price to realize the difference.
– The cash market price converges with the Futures market price at the end of the contract period. Thus it delivers risk-free profit for the investor/trader.
– Price movements do not affect initial price differential because the profit in one market is set-off by the loss in the other market.
– Since mutual funds invest own funds, the difference is fully the return.
Hence, Arbitrage funds are considered to be a good choice for cautious investors who want to benefit from a volatile market without taking on too much risk.

Index Funds
Index funds create a portfolio that mirrors a market index.
– The securities included in the portfolio and their weights are the same as that in the index
– The fund manager does not rebalance the portfolio based on their view of the market or sector
– Index funds are passively managed, which means that the fund manager makes only minor, periodic adjustments to keep the fund in line with its index. Hence, Index fund offers the same return and risk represented by the index it tracks.
– The fees that an index fund can charge is capped at 1.5%
Investors have the comfort of knowing the stocks that will form part of the portfolio, since the composition of the index is known.

Exchange Traded Funds (ETFs)
An ETF is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund.

• ETFs are listed on stock exchanges.
• Unlike regular mutual funds, an ETF trades like a common stock on a stock exchange. The traded price of an ETF changes throughout the day like any other stock, as it is bought and sold on the stock exchange.
• ETF Units are compulsorily held in Demat mode
• ETFs are passively managed, which means that the fund manager makes only minor, periodic adjustments to keep the fund in line with its index
• Because an ETF tracks an index without trying to outperform it, it incurs lower administrative costs than actively managed portfolios.
• Rather than investing in an ‘active’ fund managed by a fund manager, when one buy units of an ETF one is harnessing the power of the market itself.
• Suitable for investors seeking returns similar to index and liquidity similar to stocks

Fund of Funds (FoF)

• Fund of funds are mutual fund schemes that invest in the units of other schemes of the same mutual fund or other mutual funds.
• The schemes selected for investment will be based on the investment objective of the FoF
• The FoF have two levels of expenses: that of the scheme whose units the FoF invests in and the expense of the FoF itself. Regulations limit the total expenses that can be charged across both levels as follows:
  – TER in respect of FoF investing liquid schemes, index funds & ETFs has been capped @ 1%
  – TER of FoF investing in equity-oriented schemes has been capped @ 2.25%
  – TER of FoF investing in other schemes than mentioned above has been capped @2%.

Gold Exchange Traded Funds (FoF)

• Gold ETFs are ETFs with gold as the underlying asset
  – The scheme will issue units against gold held. Each unit will represent a defined weight in gold, typically one gram.
  – The scheme will hold gold in form of physical gold or gold related instruments approved by SEBI.
  – Schemes can invest up to 20% of net assets in Gold Deposit Scheme of banks
• The price of ETF units moves in line with the price of gold on metal exchange.
• After the NFO, units are issued to intermediaries called authorized participants against gold or funds submitted. They can also redeem the units for the underlying gold

Benefits of Gold ETFs

• Convenience --> option of holding gold electronically instead of physical gold.
  – Safer option to hold gold since there are no risks of theft or purity.
  – Provides easy liquidity and ease of transaction.
• Gold ETFs are treated as non-equity oriented mutual funds for the purpose of taxation.
  – Eligible for long-term capital gains benefits if held for three years.
  – No wealth tax is applicable on Gold ETFs

International Funds

• International funds enable investments in markets outside India, by holding in their portfolio one or more of the following:
  – Equity of companies listed abroad.
  – ADRs and GDRs of Indian companies.
  – Debt of companies listed abroad.
  – ETFs of other countries.
  – Units of passive index funds in other countries.
  – Units of actively managed mutual funds in other countries.
• International equity funds may also hold some of their portfolios in Indian equity or debt.
  – They can hold some portion of the portfolio in money market instruments to manage liquidity.
• International funds gives the investor additional benefits of
  – Diversification, since global markets may have a low correlation with domestic markets.
  – Investment options that may not be available domestically.
  – Access to companies that are global leaders in their field.
• There are risks associated with investing in such funds, such as –
  – Political events and macro economic factors that are less familiar and therefore difficult to interpret
  – Movements in foreign exchange rate may affect the return on redemption
  – Countries may change their investment policy towards global investors.
• For the purpose of taxation, these funds are considered as non-equity oriented mutual fund schemes.

Applicable for the Financial Year 2023-24

I. Tax Rates For Mutual Fund Investors

*With indexation $Without indexation@IDCW = Income Distribution cum Capital Withdrawal

Tax & TDS are subject to applicable Surcharge and Health & Education Cess at the rate of 4%. Please see the Notes below

Notes:

1. Provided that the mutual fund units are held as capital assets.
2. Tax to be deducted at source at the rate of 20% [plus applicable surcharge, if any, and Health and Education Cess @ 4% on income-tax and surcharge] or at the rate specified under the relevant double tax avoidance agreement, whichever is lower as per section 196A of the Income tax Act, 1961 (‘the Act’).
3. Securities Transaction Tax ('STT') is applicable only in respect of sale of units of Equity-oriented funds (EOFs) on a recognised stock exchange and on repurchase (redemption) of units of EOFs by the mutual fund. STT in not applicable in respect of purchase/ sale/ redemption of units of other schemes (other than EOFs).
4. Non-resident individuals (NRI) shall be entitled to be governed by provisions of the applicable Tax Treaty, which India has entered with the country of residence of the NRI, if that is more beneficial than the provisions of the Act , subject to certain conditions. As per section 90(4) of the Act, a non-resident shall not be entitled to claim treaty benefits, unless the non-resident obtains a Tax Residency Certificate of being a resident of home country. Furthermore, as per section 90(5) of the Act, non-resident is also required to provide such other documents and information, as prescribed by CBDT, as applicable.
5. As per section 112 of the Act, long-term capital gains in case of NRIs would be taxable @ 10% on transfer of capital assets, being unlisted securities, computed without giving effect to first and second proviso to section 48 i.e., without taking benefit of foreign currency fluctuation and indexation benefit.
6. Relaxation to NRIs from deduction of tax at higher rate (except income distributed by mutual fund) in the absence of Permanent Account Number (PAN) is subject to the NRI providing specified information and documents. As per provisions of Section 206AA of the Act, if there is default on the part of a NRI (entitled to receive redemption proceeds from the Mutual Fund on which tax is deductible under Chapter XVII of the Act) to provide its PAN, the tax shall be deducted at higher of the following rates: i) rates specified in relevant provisions of the Act; or ii) rate or rates in force; or iii) rate of 20%. However, the provisions of section 206AA of the Act shall not apply, if the requirements as stated in Rule 37BC of the Income-tax Rules, 1962, are met.
7. Section 206AB of the Act provides for higher rate for TDS for the non-filers of income-tax return. The TDS rate in this section is higher of the following rates: i) twice the rate specified in the relevant provision of the Act; or ii) twice the rate or rates in force; or iii) the rate of five per cent. However, the said provision does not apply to a non-resident who does not have a permanent establishment in India and a person who is not required to furnish the return of income for the assessment year relevant to the said previous year and is notified by the Central Government in the Official Gazette in this behalf.
8. Surcharge Rate as a percentage of Income-tax
   
   

   Tax Status	Income < ₹50 lakh	Income > ₹50 lakh but < /= ₹1 crore	Income > ₹1 crore but < /= ₹2 crore	Income > ₹2 crore but < /= ₹5 crore	Income > ₹5 crore
   Individual / HUF/ AOP (resident & foreign)*	NIL	10%	15%	25%	37%
   Tax Status	Income < /= ₹1 crore	Income > ₹1 crore, but < /= ₹10 crore	Income > ₹10 crore	-	-
   Partnership Firm (Domestic / foreign)	NIL	12%	12%	-	-
   Domestic company	NIL	7%	12%	-	-
   Domestic company (opting for new tax regime)	NIL	10%	10%	-	-
   Foreign company	NIL	2%	5%	-	-

   In addition, “Health and Education Cess” @ 4% shall be applicable on aggregate of base tax and surcharge.
   * The surcharge rate applicable to capital gains taxable under section 112, 112A and 111A of the Act is capped to 15%.
   *In case investor is opting for ‘New Tax Regime’ under section 115BAC (1A) of the Act , the rate of surcharge is capped at 25%.
   ** The surcharge rates in the case of an association of persons consisting of only companies as its members as under —
   
   

   Particulars	Rate
   Income > ₹50 lakh but <= ₹1 crore	10%
   Income > ₹1 crore	15%

9. There shall be no TDS deductible if dividend income paid / credited in respect of units of a mutual fund is below ₹ 5,000 in a financial year.
10. Capital gains arising on the transfer or redemption of equity-oriented units held for a period of more than 12 months, immediately preceding the date of transfer, should be regarded as 'long-term capital gains'. Finance Act 2023 has introduced section 50AA which provides that any gains on transfer / redemption of units of specified mutual funds acquired on or after 1 April 2023 are deemed as short-term capital gains. For the purposes of section 50AA, “specified mutual fund” means a mutual fund by whatever name called, where not more than 35% of its total proceeds is invested in the equity shares of domestic companies. An “equity-oriented fund” which invests in units of another fund instead of investing directly in equity shares of domestic company may be regarded as “specified mutual fund” as per section 50AA of the Act and taxed accordingly.
11. Capital gains arising on transfer or redemption of Units of schemes other than EOF and other than specified mutual fund as per section 50AA of the Act shall be regarded as long-term capital gains, if such units are held for a period of more than 36 months immediately preceding the date of such transfer.
12. As per section 112A of the Act, long-term capital gains on transfer of units of EOFs exceeding ₹ 100,000 shall be taxable @10% provided transfer of such units is subject to STT, without giving effect to first and second proviso to section 48 i.e., without taking benefit of foreign currency fluctuation and indexation benefit. Further, cost of acquisition to compute long-term capital gains is to be higher of (a) Actual cost of acquisition; and (b) Lower of (i) fair market value as on 31 January 2018; and (ii) full value of consideration received upon transfer.
13. If a company decides to opt for the new taxation regime as per the Taxation Law Amendment Act, 2019, then tax shall be levied at the rate of 22%. i.e., the lower rate of 22% is optional and subject to fulfilment of certain conditions as provided in section 115BAA.
14. The first proviso to Section 115BAB provides that any income which is not derived from nor is incidental to manufacturing or production of an article/ thing and in respect of which no specific tax rate is specified under Chapter XII of the Act, would be taxable at 22% and no deduction would be allowed while computing such income.
15. Tax shall be levied @ 25%, if the total turnover or gross receipts of the financial year 2021-22 does not exceed ₹ 400 crores. Further, the domestic companies are subject to minimum alternate tax (except for those who opt for lower rate of tax of 22%) not specified in above tax rates.
16. Securities Transaction Tax (STT) in respect of Units equity-oriented mutual fund Schemes
    
    

    Transaction	Rates	Payable by
    Purchase of units of equity-oriented mutual fund	Nil	Not Appliable
    Sale of units of equity-oriented mutual fund (delivery based)	0.001%	Seller
    Sale of units of equity-oriented mutual fund (non-delivery based)	0.025%	Seller
    Sale of units of an equity-oriented fund to the Mutual Fund	0.001%	Seller

17. Various Categories of MF Schemes which fall under "Other than Equity Oriented Funds”:
    
    • Liquid Funds /Money Market Funds / Income Funds (Debt Funds) / Gilt Funds
    • Hybrid Fund (Equity exposure < 65%)
    • Gold ETFs / Bond ETF / Liquid ETF
    • Fund Of Funds (Domestic) other than Fund of funds as defined under the “Equity Oriented Fund” definition under section 112A of the Act
    • Fund Of Funds Investing Overseas
    • Infrastructure Debt Funds
    • Specified mutual funds as defined under section 50AA of the Act

II. Other Tax Provisions

1. Capital gains arising on Transfer of units upon consolidation of mutual fund schemes of two or more schemes of EOFs or two or more schemes of a Scheme other than EOF in accordance with SEBI (Mutual Funds) Regulations, 1996 is exempt from capital gains tax.
2. Likewise, Capital gains arising on Transfer of units upon consolidation of Plans within a mutual fund scheme in accordance with SEBI (Mutual Funds) Regulations, 1996 is exempt from capital gains tax.
3. Currently, switching units of mutual fund within the same scheme from Growth Plan to Dividend Plan and vice-versa is subject to capital gains tax.
4. Creation of segregated portfolio: SEBI has permitted creation of segregated portfolio of debt and money market instruments by mutual fund schemes in certain situations. As per the said SEBI circular, all existing unit holders in the affected mutual fund scheme as on the date of the credit event shall be allotted equal number of units in the segregated portfolio as held in the main portfolio. As per sub-sections (2AG) and (2AH) to Section 49 of the Act, cost of acquisition of a unit or units in a segregated portfolio shall be the amount which bears to the cost of acquisition of a unit or units held by the assessee in the total portfolio in the same proportion as the net asset value of the asset transferred to the segregated portfolio bears to the net asset value of the total portfolio immediately before the segregation of portfolios. Further, the cost of acquisition of the original units held by the unit holder in the main portfolio shall be reduced by the amount as so arrived for the units of segregated portfolio.
5. An Equity Oriented Mutual Fund has been defined in section 112A of the Act. As per the said definition, a fund of fund scheme structure shall be treated as an Equity Oriented Fund if:
   
   • a minimum of ninety per cent of the total proceeds of such fund is invested in the units of such other fund; and
   • such other fund also invests a minimum of ninety per cent of its total proceeds in the equity shares of domestic companies listed on a recognised stock exchange
   Thus, if a fund invests in units of other funds and fulfills the aforementioned criteria, then it shall be regarded as Equity Oriented Fund. However, if the aforementioned conditions are not fulfilled, then the same shall be regarded as other than Equity Oriented Fund and subjected to the same tax treatment as applicable to a non-equity-oriented fund. However, section 50AA of the Act deems any gains on transfer / redemption of units of specified mutual funds acquired on or after 1 April 2023 as short-term capital gains. For the purposes of section 50AA, “specified mutual fund” means a mutual fund by whatever name called, where not more than 35% of its total proceeds is invested in the equity shares of domestic companies. Accordingly, an “equity-oriented fund” which invests in units of another fund instead of investing directly in equity shares of domestic company may be regarded as “specified mutual fund” as per section 50AA of the Act and taxed accordingly.
6. Bonus Stripping: As per Section 94(8), the loss due to sale of original units in the schemes, where bonus units are issued, will not be available for set off; if original units are: (A) bought within three months prior to the record date fixed for allotment of bonus units; and (B) sold within nine months after the record date fixed for allotment of bonus units. However, the amount of loss so ignored shall be deemed to be the cost of purchase or acquisition of such unsold bonus units held on the date of transfer of original units. The provision of this sub section are also applicable to securities. Further, the definitions of the terms “unit” and “record date” also include the units of business trusts (i.e. Real Estate Investment Trusts [REITs]/ Infrastructure Investment Trusts [InvITs]) and units of Alternate Investment Funds in the ambit of the said section.

Disclaimer

The above information is provided for basic guidance for investments in mutual funds and is based on provisions of the Income-tax Act, 1961, as sought to be amended by the Finance Act, 2023. The tax implications may vary for each assessee based on the details of his income. All rates and figures appearing are for illustrative purposes only. Tax benefits are subject to change in tax laws. Contents of this note have been drawn for informative purpose only and it is neither a complete disclosure of every material fact of Income-tax Act, 1961 nor does it constitute tax or legal advice. The AMC/Trustee/ Sponsor accept no liability whatsoever for any direct or consequential loss arising from any information provided in this note. Investors are advised to consult their tax advisor before taking any investment decision.