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Big Budget Change: Dividend Income from Mutual Funds Now Fully Taxable

Vikram Singh
By Vikram Singh
4 min read
Published: 27 Feb 2026
Equity Mutual Funds
Equity Mutual Fund: The year 2026 has begun with significant changes in the world of investing. Now, if you invest in mutual funds, you’ll need to focus not just on superficial returns but on the “actual profit after tax.” In the February 2026 budget, the central government has tightened the rules regarding mutual funds and dividend income even more than before.
While capital gains tax rates have already been increased, the interest exemption on dividends has also been completely eliminated. In this article, we’ll explore in detail how these new rules, effective April 1, 2026, will impact your finances and how you can save tax by adjusting your investment strategy.

Capital Gains Tax

The exact calculation of tax in mutual funds depends on how long you’ve held your units in your portfolio. For equity-oriented funds, which have at least 65 percent of their funds invested in Indian stocks, two main categories have been defined.
Equity Mutual Funds
Equity Mutual Funds
Short-term capital gains (STCG) apply when you redeem your investment before the completion of the 12-month period. This tax will now be directly taxed at a rate of 20 percent, which is a major setback for traders looking to make short-term profits.
Long-term capital gains (LTCG), on the other hand, are for investors who stay in the market for more than 12 months. The silver lining here is that total profits up to ₹1.25 lakh per annum are completely tax-free, but once your profits exceed this limit, you will be taxed at a rate of 12.5 percent on the additional amount, which no longer receives any indexation benefits.

Ban on dividend income and interest deductions

In this year’s budget, the government has dealt a major blow to astute investors who often take loans to invest heavily in mutual funds or stocks. Under previous rules, if you took out a loan for investment, you could claim up to 20 percent of the interest paid on the loan against your dividend income, reducing your tax burden.
However, under the new rules, which will come into effect from April 1, 2026, no deduction for ‘interest expense’ will be available against dividends received from mutual funds. Your entire dividend income will now be added directly to your total income and taxed according to your personal income tax slab. Furthermore, if your annual dividend from a single mutual fund house exceeds the ₹10,000 threshold, a 10 percent TDS will be deducted.

Taxes for Hybrid and Debt Funds

If you choose to invest in hybrid or debt funds instead of pure equity funds, the tax rules will depend on the equity component of that particular fund. Aggressive hybrid funds with equity exceeding 65 percent will be subject to the same rules as pure equity.
Equity Mutual Funds
Equity Mutual Funds
However, in balanced or multi-asset funds with equity between 35 and 65 percent, you will have to wait at least 24 months to realize long-term gains, before the 12.5 percent tax rate becomes effective. In the case of pure debt-oriented funds, regardless of the age of the investment, all profits will be added directly to your income and taxed at your current tax slab, i.e., 20 or 30 percent, as the separate benefit of long-term capital gains has now been eliminated.

How to Legally Save Your Profits

Despite rising tax rates, there are some effective ways to significantly reduce your tax burden. The first method is “tax loss harvesting,” whereby if some funds in your portfolio are making losses, you can sell them and set them off against your profits, reducing your total taxable income.
The second method is to smartly utilize the annual exemption of ₹1.25 lakh. You can sell some units at the end of March each year, book profits, and immediately reinvest them. Furthermore, investors should always choose the “growth option” over the “dividend option,” as dividends are taxed at your slab rate, which can often be very high, while the growth option only requires you to pay a lower-rate capital gains tax.
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