# SEBI proposes removal of capital gains tax on mutual fund switch after 1-year

> SEBI has proposed removal of long-term capital gains tax on mutual fund switches held for more than one year. If the government accepts the proposal, investors could find it easier to move out of unsuitable funds and rebalance their portfolios without an immediate tax liability.

- **URL**: https://www.arihantplus.com/blogs/mutual-funds/sebi-proposes-removal-of-capital-gains-tax-on-mutual-fund-switch-after-1-year
- **Category**: Mutual Funds
- **Author**: [Arihant Team](https://www.arihantplus.com/author/arihant-team)
- **Published**: 2026-11-12
- **Updated**: 2026-11-12
- **Reading time**: 10 minutes read

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## Key takeaways

* _Switching mutual funds is currently treated as a redemption from the existing scheme and may incur capital gains tax even if you don't withdraw the money in your bank account._
* _SEBI has reportedly recommended that capital gains from switching mutual funds held for more than one year should not attract long term capital gains tax (LTCG)._
* _The proposal could help investors exit underperforming funds, rebalance their portfolios and move to schemes that better match their financial goals and risk appetite._
* _This is only a proposal at the moment. The government will decide whether to accept it, and the exact eligibility conditions are yet to be clarified._
* _Until the government announces a change, existing capital gains tax rules will continue to apply to mutual fund switches._

## Introduction

Imagine you invested in an equity mutual fund a few years ago. Your investment has grown, but the fund has consistently underperformed its benchmark. You've been wanting to move your money into another fund that better suits your financial goals. However, there is just one thing holding you back: the capital gains tax you may have to pay when you switch.  

This is a common dilemma for mutual fund investors. Even when you move your money directly from one mutual fund scheme to another, the tax department treats the transaction as a redemption followed by a fresh investment. In other words, you may have to pay tax on your gains even though you haven't withdrawn the money for personal use.  

Securities and Exchange Board of India (SEBI) has reportedly proposed a change to address this issue. It has recommended allowing investors to switch between mutual fund schemes without attracting long-term capital gains tax, provided they have held their investments for more than one year.  

If the government accepts this recommendation, it could make portfolio rebalancing easier and reduce the tax-related hurdle when investors want to move out of unsuitable funds.  

However, this is still a proposal, not a change in the law. Let's understand how mutual fund switches are taxed today, what SEBI has recommended and how it could affect your investments.

## What does switching mutual funds mean?

Switching mutual funds moves your money from one mutual fund scheme to another within the same Asset Management Company (AMC).

Suppose you switch from XYZ Flexi Cap Fund to ABC Large Cap Fund. You are moving your investment out of the flexi cap fund and into the large cap fund. However, money does not move in or out of your bank account when you switch between mutual funds.

Your units in the old fund (XYZ Flexi Cap Fund) are redeemed and the money is automatically used to buy units in the new fund (ABC Large Cap Fund). But there's a catch.

A switch is treated as two different actions:

* You have redeemed units from one mutual fund scheme.
* You have made a fresh investment into another mutual fund scheme.

This is why a mutual fund switch can trigger capital gains tax, if your investment made a profit.

## How are capital gains from mutual funds taxed?

Capital gains are the profits you make when you redeem or switch your mutual fund units. The tax you pay depends on the type of fund, how long you have held the units and, in some cases, when you purchased them.  

Here's how the broad rules work.  

**1\. Equity-oriented mutual funds**  
Equity-oriented mutual funds have the following capital gains tax rates:

* **Short-term capital gains (STCG):** If you sell or switch your units within 12 months, your gains are taxed at 20%.
* **Long-term capital gains (LTCG):** If you sell or switch your units after holding them for more than 12 months, gains exceeding INR 1.25 lakh in a financial year are taxed at 12.5%.

The INR 1.25 lakh exemption is an aggregate annual limit. It applies to eligible long-term gains from equity-oriented mutual funds, listed equity shares and business trust units together, rather than separately to each mutual fund scheme.

**2\. Debt and other non-equity mutual funds**  
The taxation of non-equity funds is more complicated because it depends on the fund category, date of investment and whether the units are listed or unlisted.  

* **Specified debt-oriented mutual funds acquired on or after April 1, 2023:** Gains are generally treated as short-term capital gains and taxed at your income tax slab rate, irrespective of how long you hold the units. Under the current definition, this broadly covers funds investing more than 65% of their proceeds in debt and money market instruments, as well as certain funds investing in such debt-oriented funds.
* **Other non-equity mutual funds:** The holding period for long-term capital gains generally depends on whether the units are listed or unlisted. For transfers under the current rules, listed units generally qualify as long-term after more than 12 months, while unlisted units generally require a holding period of more than 24 months. Qualifying long-term gains are generally taxed at 12.5% without indexation. Short-term gains are generally taxed at your income tax slab rate.

Therefore, not all debt and non-equity mutual funds follow the same tax rules.

## SEBI's proposal of LTCG tax relief on mutual fund switches after one year

SEBI has reportedly recommended that investors should be allowed to switch between mutual fund schemes without attracting long-term capital gains tax, provided they have held their units for more than one year.  

The recommendation forms part of SEBI's pre-Budget representations to the Ministry of Finance ahead of Union Budget 2027-28.  

Today, you may hesitate to switch out of a mutual fund because doing so could trigger a substantial tax liability. This can happen even when the fund no longer matches your financial goals or risk appetite.  

For example, you may have invested in a small-cap fund when you had a long investment horizon and were comfortable taking higher risks. As you approach an important financial goal, you may want to move some of your money into a large-cap or debt fund to reduce portfolio risk.  

However, you prefer holding on to these funds to avoid paying capital gains tax.

This is where SEBI's recommendation can help you rebalance your portfolio by removing this tax-related hurdle. If implemented, investors could potentially move between eligible schemes after the stipulated holding period without an immediate LTCG tax liability.  

Let us understand the impact of the proposed change with an example.

Suppose you invested INR 6 lakhs in an equity mutual fund scheme 3 years back, which is now worth INR 9 lakhs. You want to switch to a debt mutual fund scheme to protect your investment from market volatility.

Your capital gains work out to: INR 3 lakh (INR 9 lakhs minus INR 6 lakhs)  
Since you have held the equity fund for more than 12 months, your gains currently qualify as long-term capital gains and are taxed.  

Assuming you have no other eligible long-term capital gains during the financial year, the first INR 1.25 lakh is exempt from tax. You pay 12.5% tax on the remaining INR 1.75 lakh.   

So, if you switch from your equity fund scheme to a debt fund scheme, you will incur capital gains tax of INR 21,875\. If SEBI's proposal goes through you will incur zero capital gains tax when switching between mutual fund schemes held for over a year. 

| | **Today**                         | **If SEBI proposal passes** |                    |
| ----------------------------------- | --------------------------- | ------------------ |
| **Long Term Capital Gains**         | INR 3 lakhs                    | INR 3 lakhs           |
| **Taxable (above** INR **1.25 lakhs)** | INR 1.75 lakhs                 | Zero tax at switch |
| **Taxed at 12.5%**                  | INR 21,875                     | INR 0                 |

Note: We have not considered cess and surcharge in the above example.

## Things to consider about SEBI'S proposal

While SEBI has given a broad guideline of this proposal, there are, however, some important details that are yet to be clarified.

1. **Will all mutual fund categories qualify?**
2. **Will switches between different AMCs qualify?**
3. **Will the tax be exempted or deferred?**
4. **Will Regular-to-Direct plan switches qualify?**
  
Also, SEBI's recommendation is not binding on the government. Until the Finance Ministry announces a change through the appropriate legal process, existing tax rules will continue to apply.

## How could SEBI's proposal benefit mutual fund investors?

If implemented, the proposal could make it easier to:  

* **Exit underperforming funds:** Move out of funds that consistently underperform their benchmarks and peers.
* **Rebalance your portfolio:** Adjust your equity and debt allocation as your financial goals and investment horizon change.
* **Manage risk:** Switch out of funds whose investment strategy no longer matches your risk appetite.

However, switching should be based on suitability, not short-term performance. Exit loads may still apply, and stamp duty of 0.005% will continue to be payable on switch-in transactions.

## When should you switch mutual funds?

Even if the government accepts SEBI's proposal, you should not switch mutual funds simply because you can do so without paying immediate capital gains tax.  

Switching should be based on your investment goals and the suitability of the fund.  
Here are some situations where you could consider switching.

* **Underperforming funds:** You could switch your mutual funds if they have underperformed their benchmark and category over three or more years. Do not switch your fund if it has underperformed for only a year or two because this may be due to short term market volatility.

* **Investment strategy:** Suppose a fund shifts its investment mandate and this change does not match your financial goals and risk appetite. For example, a fund which mainly invested in large cap stocks shifts its focus towards mid and small cap stocks and you are uncomfortable with the higher risk. Then you could switch out of this fund.

* **Goals changed:** Getting closer to your financial goals, a change in your income, or realizing you can't handle the volatility of the fund are valid reasons to switch out of the fund.

## Investor takeaway

SEBI's recommendation to remove long-term capital gains tax on eligible mutual fund switches could make portfolio management easier for investors.  

Today, you may hesitate to exit an underperforming or unsuitable fund because switching can trigger a tax liability. If the proposal becomes law, you could have greater flexibility to rebalance your portfolio and move your investments to schemes that better match your financial goals.  

However, easier switching does not necessarily mean better investment outcomes.  

The proposal could also encourage investors to frequently move between schemes just to chase previous year's top performers for higher returns. Such behaviour can disrupt long-term wealth creation and lead to investments that do not match their risk appetite.  

Remember, the purpose of switching should be to improve your portfolio, not to chase short-term returns or react to every market movement.  

Also, these are SEBI's reported recommendations submitted ahead of the Union Budget 2027-28\. The government has not announced any change in the taxation of mutual fund switches. The exact scope, eligibility conditions and tax treatment are yet to be clarified.  

Until the proposal is formally accepted and the rules are notified, existing capital gains tax provisions will continue to apply.

## FAQs

**Do you incur capital gains tax when switching from regular to direct funds?**

Yes, you will incur capital gains tax if you switch from regular to direct mutual fund schemes. The switch is counted as a redemption from the regular plan and a fresh investment into the direct plan.

**Can I switch into mutual fund schemes of other AMCs?**

No, you cannot switch into mutual fund schemes of other AMCs. A "switch" only works between mutual fund schemes of the same AMC.

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*Investments in securities markets are subject to market risks. Read all the related documents carefully before investing. This content is for educational purposes only and does not constitute investment advice. Arihant Capital Markets Ltd. is a SEBI-registered stock broker.*