Mutual Funds have been around for a while. However, there is still a lot of awareness and investors attention is required in the investment vehicle. For higher returns coupled with greater risk, investors invest in equity funds and for a steady and fixed return, investors invest in debt funds. The capital gain taxation also varies according to the type of the fund. There are three parts of mutual fund taxation. First is the type of mutual fund, with the equity-oriented funds getting a different tax treatment compared to other types of funds. Second is the period of holding. For equity-oriented mutual funds, the \u201clong-term\u201d is one year and for all other funds, it is three years. These two factors determine the rate of tax that will apply to every redemption transaction. The third factor will determine the gain amount on which this tax rate will apply. And that factor is how to calculate the gain. ALSO READ: Mutual Fund Investment: 6 Criteria for picking the right mutual fund How taxation in SIP works Let's assume you have a SIP of Rs 5,000 per month in an equity-oriented fund. In this case, the rate of taxation that will apply will be 10 per cent for long-term capital gains. Since you will be redeeming from the fifth year, by which time you would have invested Rs 2.4 lakh through your SIP, it is highly likely that the Rs 1 lakh that you withdraw would be a long-term transaction. In any redemption transaction, if there are more units in the investment that are required for withdrawal, the earliest units invested are considered as having been redeemed. To calculate capital gains that will be subject to 10 per cent tax, you will have to average the cost of acquisition of the units and subtract that from the redemption amount. From that amount, you will need to subtract Rs 1 lakh that the IT law exempts from the taxation for capital gains. The remaining amount will be subject to LTCG rate of 10 %. ALSO READ: Mutual Fund Investment: For diversification adopt a contrarian fund strategy Tax saving breed of mutual funds Although all equity funds exempt you from paying a long-term capital gains tax of 10.4% up to an amount of Rs 1 lakh, there is one breed of equity funds that gives you tax deduction benefits at the time of making an investment. These are equity-linked saving schemes (ELSS), more popularly known as tax saving mutual fund schemes. An ELSS gives you tax deduction benefit of up to Rs 1.5 lakh under section 80C. This is the only pure equity investment vehicle offering section 80C deduction benefits. The only catch is that it comes with a 3-year lock-in. Other equity funds don't carry a lock-in. Remember, the lock-in also applies to your systematic investment plans (SIPs); every monthly instalment you make in an ELSS is subject to a 3-year lock-in. ALSO READ: Mental Illness in Health Plans: What you can look forward to after IRDA's recent directive Other than deduction benefits and the lock-in, the ELSS is quite the same as a diversified equity fund. It invests in equity shares of companies across sectors and market capitalisations. When investing in ELSS, care should be taken to not invest in a new scheme every year to save taxes. One ELSS in the portfolio in which you keep topping up every year is more than enough. Leaving aside equity mutual funds, debt mutual funds are a useful tool for those who are not willing to take high risks yet aim for capital protection. It offers a steady return and there has been a pattern in the past where people are moving to debt mutual funds from fixed deposits for a better return. The capital gain on the debt fund depends on the plan you have opted for. Whether it is a growth or dividend fund, when you subtract initial investment from current sale or redemption value, you estimate your capital gains. It is important to know the amount of gain in a debt fund irrespective of the fact that you want to redeem or sale. Calculation of debt fund capital gain is easier because it gives a fixed income. ALSO READ: Private Equity Investment: Way to earn more than 20% return annually Calculating Capital Gains The impact of tax depends on the period you choose to keep the fund with yourself. You need to count the number of days from the day of purchase to the day of sale or redemption. If the investment tenure is less than three years, then it is a short-term capital gain. For holdings above three years, it becomes a long-term capital gain. The benefit of indexation (using indexation index to determine the cost of acquisition) is available in the case of a long-term capital asset. This indexation is nothing but an adjustment against inflation. This indexation is done by multiplying cost inflation index (CII) of the year of sale and dividing it by CII of the year of purchase. The long-term tax liability is 20% of the gain amount calculated.