The mutual fund rebate in income tax comes from Section 87A, and for FY 2025-26 it can eliminate your tax bill on mutual fund income that is taxed at slab rates, provided your total income stays within the threshold: ₹12,00,000 under the new regime (rebate up to ₹60,000) or ₹5,00,000 under the old regime (rebate up to ₹12,500).1Income Tax Department. Income Tax Act Section 87A The catch is that the rebate does not cover capital gains on equity mutual funds taxed at special rates, so a redemption can leave you with tax to pay even when your total income sits below the rebate line.
How the Rebate Applies to Mutual Fund Income
Section 87A gives resident individuals a rebate that reduces tax liability directly, applied after deductions and before the 4% health and education cess. Under the old regime, tax up to ₹12,500 is wiped out if total income does not exceed ₹5,00,000. Under the new regime for FY 2025-26, the Finance Act 2025 raised the rebate to ₹60,000 for total income up to ₹12,00,000, which makes income below that threshold effectively tax-free for slab-rate items.
Your mutual fund income counts toward total income for this calculation. That includes dividends from any mutual fund, gains on debt fund units purchased on or after 1 April 2023, and capital gains on equity funds. If a redemption or dividend pushes your total income past the threshold, you can lose the rebate entirely. The new regime does provide marginal relief so the tax payable never exceeds the amount by which income crosses ₹12 lakh, but the jump still catches people out.1Income Tax Department. Income Tax Act Section 87A
Why the Rebate Does Not Cover Equity Fund Capital Gains
This is the single most misunderstood part of the mutual fund rebate. From FY 2025-26, the Finance Act 2025 inserted a proviso stating that the Section 87A rebate cannot offset tax on income taxed at special rates. Short-term capital gains on equity mutual funds fall under Section 111A and are taxed at 20%. Long-term capital gains on equity mutual funds fall under Section 112A and are taxed at 12.5% above the ₹1,25,000 annual exemption. Both are special-rate income, and both are excluded from the rebate.
So if you redeem equity mutual fund units and generate capital gains, the tax on those gains stands on its own. Keeping total income under ₹12 lakh does not mean zero tax on everything. It means zero tax on the slab-rate portion. An investor with ₹10 lakh of salary and ₹2 lakh of long-term equity fund gains still owes tax on the gains above the ₹1.25 lakh exemption, even though the salary portion is fully rebated.
Which Mutual Fund Income Is Actually Rebate-Eligible
Because the special-rate exclusion carves out most equity fund gains, the mutual fund income that the rebate does help with is the slab-rate income:
- Dividends from any mutual fund, equity or debt. Since FY 2020-21 these are fully taxable in the investor’s hands at slab rates under both regimes. Fund houses deduct TDS at 10% under Section 194K once dividends from a fund house cross the prescribed threshold, or 20% without a PAN. That TDS credit appears in Form 26AS and can be refunded if your final liability is nil after the rebate.
- Gains on debt mutual fund units purchased on or after 1 April 2023. All such gains are treated as short-term regardless of holding period and taxed at your slab rate. Because these are slab-rate rather than special-rate, they sit inside the rebate’s reach.2HDFC Mutual Fund. Are the Recent Changes to MF Taxation Confusing You
Debt fund units purchased before 1 April 2023 follow the older rules (long-term at 20% with indexation after 36 months), and that special rate would sit outside the rebate as well. If you hold both vintages, they need to be tracked separately.
Timing Redemptions to Keep the Rebate
Because a single large redemption can tip your total income over the threshold and cost you the whole rebate on your slab-rate income, timing matters near the end of the financial year. A few practical points:
- Add up your expected salary, interest, rental income, and mutual fund dividends before you place a redemption request. If the projected total is close to ₹12 lakh (new regime) or ₹5 lakh (old regime), a redemption that adds slab-rate income can push you over.
- Equity fund capital gains do not disqualify you from the rebate directly, because they are excluded from the rebate calculation anyway. But they still form part of total income for other purposes, so read your capital gains statement carefully.
- Partial redemptions across two financial years can keep total income under the threshold in each year. Fund houses and registrars like CAMS and KFintech apply first-in-first-out to identify which units are being sold, so your oldest units go first.
ELSS and Section 80C: The Other Mutual Fund Tax Break
The rebate is not the only mutual fund tax relief in the code. Equity Linked Savings Schemes are the only category of mutual fund that qualifies for a deduction under Section 80C, up to ₹1,50,000 per financial year. Because the deduction reduces gross total income before the rebate is tested, ELSS investments can help pull your total income under the ₹5 lakh threshold that unlocks the old regime rebate.
Section 80C is not available under the new regime. The new regime removed most Chapter VI-A deductions in exchange for lower slab rates and the higher rebate ceiling.3Income Tax Department. FAQs on New Tax vs Old Tax Regime So the choice is between the old regime with ELSS and other 80C investments up to ₹1.5 lakh, or the new regime with a much larger rebate but no 80C. An investor in the 30% bracket who fully uses 80C saves up to ₹46,800 through the deduction alone, but the new regime’s ₹60,000 rebate on income up to ₹12 lakh often outperforms that for salaried investors. Running the numbers under both regimes is worth the ten minutes before you commit.
The ₹1.5 lakh cap is shared across all 80C instruments together, including life insurance premiums, PPF, home loan principal, and tuition fees. ELSS money above the cap still grows inside the fund but earns no extra deduction. The ELSS lock-in is three years from the date of each purchase, considerably shorter than PPF’s fifteen years.
Reporting the Rebate on Your Return
The rebate is not something you claim on a separate form. The income tax return computes it automatically once you fill in your income and deductions correctly. What you do need to get right is the classification of your mutual fund income so the special-rate items are not accidentally mixed with slab-rate items. Capital gains go into Schedule CG, dividends into the income from other sources schedule, and ELSS deductions into the Section 80C line of the deductions schedule.
Before filing, reconcile your Consolidated Account Statement and capital gains statement from CAMS or KFintech against Form 26AS and the Annual Information Statement on the e-filing portal. Form 26AS shows the TDS deducted on your dividends under Section 194K; the AIS lists broader transaction information. Where the two conflict, Form 26AS takes precedence for TDS credit.4Income Tax Department. View Tax Credit Mismatch FAQs Most salaried investors with mutual fund transactions will file ITR-2 rather than ITR-1, because ITR-1 does not accept capital gains.
If your slab-rate income is fully rebated but TDS was deducted on your dividends during the year, the excess comes back as a refund once the return is processed. If the rebate leaves you owing tax only on equity fund special-rate gains, that residual amount must be paid separately, either as advance tax during the year or as self-assessment tax before filing.