Taxes often decide how much of your investment return actually reaches your bank account. While many investors spend time selecting funds based on performance, fewer pay attention to how taxation works. This becomes even more important when investing in hybrid mutual funds, which combine equity and debt in different proportions. The way these funds are taxed can vary significantly, and a small misunderstanding can lead to an unpleasant surprise at the time of redemption.
This article explains what are hybrid funds, how equity and debt hybrid funds are taxed under current Indian tax laws, and what Indian residents and NRI investors should keep in mind before investing.
What Are Hybrid Funds and Why Do Investors Choose Them?
Hybrid funds are mutual fund schemes that invest in more than one asset class, usually equity and debt. Instead of choosing separate equity and debt funds, investors get both within a single portfolio. This mix is designed to balance growth and stability, depending on the fund’s equity exposure.
Hybrid mutual funds are popular because they offer flexibility. Equity helps generate long-term growth, while debt provides stability and reduces sharp market swings. Depending on your risk appetite and time horizon, you can choose from equity-heavy, balanced, or debt-oriented hybrid funds.
For investors seeking diversification without managing multiple funds, hybrid funds can be a practical solution.
How Taxation Works for Hybrid Mutual Funds in India
Taxation of hybrid funds is determined primarily by one factor: the amount of equity the fund holds. The equity allocation decides whether the fund is treated as an equity fund or a debt fund for tax purposes.
Equity-Oriented Hybrid Funds
If a hybrid fund invests at least 65 percent of its assets in equity and equity-related instruments, it is classified as an equity-oriented fund.
Tax treatment under current rules:
Short-term capital gains apply if you sell units within 12 months. These gains are taxed at 20 percent.
Long-term capital gains apply if units are held for more than 12 months. Gains up to ₹1.25 lakh in a financial year are exempt from tax. Any amount above this threshold is taxed at 12.5 percent without indexation.
This structure makes equity-oriented hybrid funds relatively tax-efficient for long-term investors. Even moderate equity exposure can yield better post-tax returns when held for more than one year.
Debt-Oriented Hybrid Funds
If a hybrid fund invests less than 65 percent in equity, it is treated as a debt fund for taxation.
After recent tax changes, the taxation of debt-oriented hybrid funds has become less favourable for new investors.
Current tax treatment:
Capital gains are added to your total income and taxed according to your income tax slab, regardless of how long you hold the investment.
Indexation benefits, which earlier reduced taxable gains by adjusting for inflation, no longer apply to investments made after April 2023.
This change has made debt-oriented hybrid funds less attractive from a tax perspective, especially for investors in higher tax brackets.
Hybrid Funds with Moderate Equity Exposure
Some hybrid mutual funds maintain equity exposure between 35% and 65%. These funds are subject to a separate tax rule.
If units are sold within 24 months, gains are treated as short-term and taxed at slab rates.
If units are held for more than 24 months, gains qualify as long-term capital gains and are taxed at 12.5 percent.
This structure sits between equity and debt taxation, offering some relief for investors willing to stay invested for longer periods.
Taxation of Dividends from Hybrid Funds
Dividends from hybrid funds are not tax-free. Any dividend received is added to your total income and taxed according to your income tax slab.
This applies to both Indian residents and NRIs. Investors who prefer regular income should factor in this tax impact, especially if they fall in higher tax brackets.
For many investors, opting for the growth option rather than the dividend option results in better long-term tax efficiency.
Tax Rules for NRI Investors in Hybrid Funds
NRI investors face the same capital gains tax rules as Indian residents, but with an additional layer of Tax Deducted at Source.
Capital Gains and TDS for NRIs
For equity-oriented hybrid funds, short-term gains are subject to TDS at 20 percent, while long-term gains are taxed at 12.5 percent after applicable exemptions.
For debt-oriented hybrid funds, TDS is usually deducted at higher rates, often aligned with the highest income tax slab. This can significantly reduce returns if not planned carefully.
Role of DTAA for NRIs
Many NRIs are eligible for relief under Double Taxation Avoidance Agreements between India and their country of residence. Depending on the treaty, some investors may be able to claim tax credits or exemptions for taxes paid in India.
However, DTAA rules differ across countries and require proper documentation and tax filing. Professional advice is strongly recommended before relying on treaty benefits.
How Investors Can Use Tax Rules to Their Advantage
Understanding taxation allows investors to structure portfolios more efficiently rather than reacting after returns are taxed.
Holding equity-oriented hybrid funds for more than one year can substantially improve post-tax outcomes.
Investors with long-term goals often benefit from higher equity exposure, as equity-friendly tax rules reward patience.
Debt-oriented hybrid funds may still suit short-term goals, but investors should be aware that slab-rate taxation can reduce net returns.
NRIs should pay close attention to TDS deductions and consider filing Indian tax returns to reclaim excess tax where applicable.
Conclusion
Hybrid mutual funds offer a balance between growth and stability, but their tax treatment depends heavily on their structure. Knowing what are hybrid funds is only the first step. Understanding how equity and debt components are taxed makes a real difference to long-term returns.
With recent changes in Indian tax laws, equity-oriented hybrid funds have become more attractive from a tax perspective, especially for long-term investors and NRIs seeking efficiency. Debt-heavy hybrids, while still useful for stability, now require more careful planning.
Tax rules may appear complex at first, but once understood, they can guide smarter investment decisions. A clear view of taxation helps ensure that the returns you earn are not quietly eroded over time.
