Union Budget 2026: What Investors Expect on Taxation of Mutual Funds
In the world of investing, there is a popular saying: It’s not just about what you make, but what you keep. At Motilal Oswal, we believe that tax efficiency is a silent driver of long-term compounding. As of late 2025, with domestic mutual fund AUM (Assets Under Management) consistently breaking records, the 2026-27 Union Budget is expected to address several tax friction points that investors have been navigating.
Through our QGLP lens, we look at the mutual fund industry's wishlist focusing on simplicity, fairness, and the promotion of a Pensioned India.
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The Core Expectation: Parity for Debt Mutual Funds
The biggest shift in recent years was the removal of Long-Term Capital Gains (LTCG) benefits for Debt Mutual Funds (with less than 35% equity) purchased after April 1, 2023. Currently, these are taxed at your slab rate the same as a Fixed Deposit.
The Investor’s Demand:
Investors are looking for the return of the Long-Term status for debt funds. Specifically, the industry expects a flat 12.5% tax rate for debt funds held for more than 24 or 36 months, similar to other asset classes.
Why it matters:
Debt funds provide essential liquidity to the corporate bond market. Tax parity would encourage investors to move beyond traditional FDs into more sophisticated debt instruments, aiding India's credit growth.
Rationalizing Equity LTCG: The Inflation Shield
For Equity Mutual Funds, the current tax rate is 12.5% on gains exceeding ₹1.25 lakh. While this rate is competitive, investors are hoping for an update to the exemption limit.
- The Expectation: Increase the annual LTCG exemption from ₹1.25 lakh to ₹2 lakh.
- Motilal’s Insight: Between 2018 (when LTCG was reintroduced) and 2025, the market has seen massive growth. A higher exemption limit would protect small and mid-sized retail investors from paying tax on nominal gains driven largely by inflation.
Simplification of Multi-Asset & Hybrid Funds
The Hybrid category including Balanced Advantage and Multi-Asset Funds has been a star performer in 2025 as investors sought stability. However, the taxation of these funds depends on their exact equity exposure (above or below 65%).
The Wishlist:
- Unified Category: Investors want a clear, simplified tax category for Hybrid Funds.
- The Proposal: A middle-tier tax rate (perhaps a flat 15% with a 2-year holding period) for any fund that maintains 35% to 65% equity, rather than the current all-or-nothing approach. This would allow for more creative asset allocation without tax surprises.
Expanding the ELSS Basket
Equity Linked Savings Schemes (ELSS) have long been a favorite for those under the Old Tax Regime (Section 80C). With the government’s push toward the New Tax Regime, ELSS is losing its incentive status.
Expectations for 2026:
- ELSS in the New Regime: A specific deduction for ELSS (perhaps up to ₹50,000) within the New Tax Regime to encourage long-term equity participation.
- Retirement Funds (NPS vs. MFs): There is a demand to bring Mutual Fund Retirement Schemes on par with the NPS (National Pension System) in terms of tax deductions under Section 80CCD.
Summary: Mutual Fund Tax Expectation Matrix
The Internal Switch Innovation
A major pain point for mutual fund investors is that moving money from a Growth option to a Dividend option (or between two schemes of the same AMC) is treated as a sale and taxed.
The Expectation: Investors are hoping for a Tax-Neutral Switch. As long as the money stays within the mutual fund ecosystem, it shouldn't be taxed until it is finally withdrawn to a bank account. This would be a massive ease of investing boost for 2026.
Final Thoughts: The Motilal Oswal View
At Motilal Oswal, our philosophy is Buy Right : Sit Tight. While the 2026 Budget may bring some tax changes, the fundamental power of equity mutual funds remains unmatched for wealth creation.
- If you are a high-income earner, focus on Equity LTCG as it is still lower than the 30% slab.
- If you are conservative, watch for potential Debt Fund relief to improve your post-tax yields.
The 2026 Budget will likely aim to make India a Nation of Investors. By aligning your portfolio with these trends now, you can stay ahead of the curve.
Explore Budget 2026 Insights - Income Tax Slab Changes | Taxpayer Expectations | Salaried Class Expectations | Standard Deduction & Rebates | Capital Gains Tax | LTCG Rule Changes | 80C & 80D Expectations