Taxation of NFOs: How NFOs are Taxed?

Understanding how NFO (New Fund Offers) are taxed is important for making informed investment decisions and improving your post-tax returns. When you invest in an NFO, the income you earn through dividends or capital gains is subject to tax*. The tax treatment depends mainly on the type of fund and how long you stay invested. Equity-oriented NFOs and debt-oriented NFOs are taxed differently under Indian tax laws. In this article, we explain how taxation of NFOs works, what determines your tax* liability, and how you can manage it efficiently.

What is taxation of NFO?

Taxation of NFOs (New Fund Offers) refers to the tax* applied to profits earned from investments made during the NFO period. When you redeem your units at a profit or receive income distributions, the gains are taxed under capital gains rules. The tax treatment depends on whether the NFO is equity-oriented or debt-oriented, based on its asset allocation. Dividends received from NFOs are also taxable in the hands of investors. Understanding this taxation helps you calculate your actual returns after tax*.

What factors determine taxation on NFO?

Several factors decide how your NFO investment is taxed. Let’s look at them one by one.
 

1. Type of fund

This is the most important factor.
 

• Equity-oriented NFOs invest at least 65% in equity shares.
  

• Debt-oriented NFOs mainly invest in bonds and fixed-income instruments.
  

• Hybrid funds are taxed based on equity exposure.

Equity funds generally offer more favourable long-term tax* treatment.
 

2. Holding period

The duration of your investment decides whether gains are short-term or long-term.
 

• Equity funds:
  

  • Less than 12 months – Short-Term Capital Gains (STCG)
    

  • More than 12 months – Long-Term Capital Gains (LTCG)
    
    

• Debt funds (purchased before 1 April 2023):
  

  • Less than 24 months - STCG
    

  • More than 24 months - LTCG

For debt funds purchased after 1 April 2023, gains are taxed* as per your income slab, regardless of holding period.

Holding period makes a clear difference to your tax* rate.
 

3. Nature of income

NFOs generate income in two ways:

• Capital gains – when you sell units at a higher price
  

• Dividends – income distributed by the fund

Each is taxed differently.
 

4. Asset allocation

In hybrid NFOs, taxation depends on equity exposure.

• 65% or more in equity – taxed as equity fund
  

• Less than 65% in equity – taxed as debt fund

So, asset mix plays a strong role in tax treatment.
 

5. Date of investment

Debt fund taxation saw a major shift from 1 April 2023. Debt-oriented NFOs purchased after this date are taxed* as per slab rates, even if held for long term.
 

That is important to keep in mind while investing.
 

6. Investor’s tax slab

For debt-oriented funds and certain gains, taxation in NFO is charged according to your income tax* slab. Investors in higher brackets pay more tax*.
 

In practice, your personal income level directly affects your post-tax returns.

How do NFOs generate profits?

Understanding how NFOs earn returns helps you see how taxation applies.
 

Capital appreciation

After the NFO closes, the fund manager invests the collected money into stocks or bonds. If the value of these assets rises, the Net Asset Value (NAV) increases. When you redeem at a higher NAV, you earn capital gains. This is usually the primary source of long-term growth for equity-oriented NFOs.
 

Dividend distribution

Funds may distribute income earned from underlying investments. If you choose the dividend option, the fund may pay out earnings periodically. These payouts depend on the fund’s performance and surplus available for distribution.
 

Interest income from Debt funds

Debt-oriented NFOs invest in government securities, treasury bills and corporate bonds. They earn interest income, which contributes to overall returns. This makes debt NFOs relatively more stable compared to equity-focused funds.
 

Trading gains

Fund managers buy and sell securities to optimise returns. Profits from such trades increase NAV. Active portfolio management can improve performance when market opportunities arise.

Overall, NFOs can grow through multiple income sources. But taxation applies when gains are realised or distributed.

Taxation of dividends offered by NFO

Dividends received from NFO investments are taxable in your hands as per your income tax slab. Since the removal of Dividend Distribution Tax (DDT) in April 2020, fund houses do not pay tax* before distributing dividends. You receive the full amount, and it must be added to your total income while filing your tax return.
 

The dividend income is taxed according to your tax bracket. If you fall in a higher slab, you will pay higher tax on it. If your total dividend income in a financial year exceeds ₹5,000, the fund house deducts 10% TDS. You can claim this TDS while filing your return.
 

There is no difference in tax* treatment between equity and debt NFO dividends. If you choose the growth option, you do not pay tax* on dividends, as gains are taxed only when you redeem the units.

Taxation of capital gains offered by NFO

Here is how capital gains from different NFO types are taxed:
 

Conclusion

Understanding NFO taxation helps you make smarter investment decisions and plan for better post-tax returns. The tax* treatment depends on the fund type, holding period, and date of investment. Equity-oriented NFOs offer relatively favourable long-term tax* benefits, including exemption up to Rs. 1.25 lakh per year. Debt-oriented NFOs purchased after April 2023 are taxed as per slab rates regardless of holding period. Considering these factors before investing can help you manage tax* liability more effectively.