SEBI Proposes Scrapping Capital Gains Tax on Mutual Fund Scheme Switches Held Over One Year — November 3, 2026

In a major pre-Budget recommendation to the central government, the Securities and Exchange Board of India (SEBI) has proposed that switching between mutual fund schemes should no longer be treated as a taxable sale, provided the investor has held the units for more than one year.

The recommendation, part of SEBI's representations submitted to the Ministry of Finance ahead of the Union Budget, aims to eliminate tax friction for long-term domestic retail investors and encourage continued participation in mutual funds.

Current Capital Gains Tax Treatment on MF Switches

Under existing Indian income tax regulations, a "switch" between schemes—even within the same asset management company (AMC)—is legally classified as a redemption from the original scheme followed by a fresh purchase in the destination scheme.

As a result, investors face an immediate capital gains tax liability, irrespective of whether the proceeds are remitted to their bank accounts or remain invested in the capital markets.

Current tax framework governing mutual fund redemptions and switches:

• Equity-Oriented Funds (Short-Term): Units held for 12 months or less attract a short-term capital gains (STCG) tax rate of 20%.
• Equity-Oriented Funds (Long-Term): Units held for more than 12 months attract a long-term capital gains (LTCG) tax rate of 12.5% on qualifying gains.
• Specified Debt Funds: Gains from investments made on or after April 1, 2023, are treated as short-term capital gains and taxed at the investor's applicable income tax slab rate.

Because switching triggers an immediate tax event, investors attempting to realign their portfolios—such as moving from mid-cap to large-cap schemes or reallocating between debt and equity—incur a cash drain on their compounding capital.

What SEBI's Proposal Entails

Under the reported proposal, any switch from one domestic mutual fund scheme to another would not constitute a transfer or taxable event for long-term capital gains purposes if the underlying units have completed a one-year holding period.

The primary beneficiary would be the disciplined investor seeking to rebalance asset allocation or exit underperforming schemes without losing a portion of their corpus to upfront taxes. The tax liability would likely defer until the unitholder completely exits the mutual fund fold into cash or a bank account.

The proposal comes alongside another key SEBI submission requesting the removal of the 12.5% LTCG tax on foreign portfolio investors (FPIs) to boost liquidity and revive overseas inflows into Indian equities.

Industry Impact and Market Context

India's mutual fund industry manages approximately ₹82.6 lakh crore in assets under management (AUM), propelled by steady retail flows through systematic investment plans (SIPs).

Despite substantial domestic participation, benchmark equity returns have faced pressure over recent periods, making unnecessary transaction friction a critical pain point. Over the past two years, average large-cap equity mutual funds have faced subdued performance, complicating active portfolio shifts for retail investors.

Industry experts point out that removing tax on switches would align mutual fund rules with modern portfolio management realities, ensuring that asset rebalancing is guided strictly by risk tolerance and market conditions rather than tax avoidance strategies.

Next Steps for Implementation

The recommendations submitted by SEBI are advisory and non-binding. The decision to amend Section 47 of the Income Tax Act, 1961—which defines transactions not regarded as transfer—rests exclusively with the central government and the Ministry of Finance.

Investors will have to wait for the official Union Budget announcement in February to see whether the government incorporates SEBI's proposal and outlines the qualifying conditions for tax-exempt switches. Until statutory amendments are passed by Parliament, existing capital gains rules will continue to apply to all mutual fund switches.