6B.11 Hybrid, arbitrage, FoF, gold, silver and international funds; tax
Motivation
Beyond plain equity and debt funds, the categories exist mostly to mix assets, to hold assets a fund cannot hold directly, or to reach a particular tax treatment. Knowing what each holds and how it is taxed is enough to decide whether you need it.
6B.11.1Hybrid, arbitrage and other funds#
What each holds
- Hybrid funds combine equity and debt: conservative hybrid (mostly debt), balanced advantage or dynamic asset allocation (equity exposure varied by a model, often with arbitrage positions to stay above 65% gross equity), aggressive hybrid (65–80% equity), multi-asset (at least three asset classes, often including gold), and equity savings funds (equity, arbitrage and debt).
- Arbitrage funds buy stocks in the cash market and sell the same stocks' futures. The hedged position earns the futures basis, the cash-and-carry return of M07 · 7.1: with spot and futures , the position locks in over , which tracks short-term interest rates. M07 Worked example 7.5 finds a Nifty futures price implying a financing rate of about 6.4% a year on 5 Nov 2026, "roughly what an arbitrage fund earns for running the cash-and-carry trade, before costs". Because the stock legs are equity, the fund is equity-oriented for tax, although its risk is that of a money-market fund.
- Fund of funds (FoFs) invest in other mutual fund schemes: a domestic FoF (often a multi-asset or asset-allocation product), an international FoF (investing in a foreign fund or ETF), or a gold or silver FoF (investing in the AMC's own ETF). The FoF's TER caps include the underlying schemes' expenses (6B.3.1).
- Gold and silver ETFs hold physical metal of standard purity in vaults (and, within limits, exchange-traded derivatives and other gold- or silver-related instruments); valuation is at domestic exchange spot prices from 1 Apr 2026 (6B.9.1).
- International funds hold foreign stocks directly or through foreign funds and ETFs, within the overseas limits (6B.9.3).
6B.11.2Tax on fund gains#
Tax (resident individual, transfers in tax year 2026-27; checked 6 Nov 2026; section numbers of the Income-tax Act, 1961 are given because the 2025 Act renumbers them: M00 · 0.7.1). Rates exclude surcharge and the 4% cess. This is not tax advice; verify with the Act and a chartered accountant before acting.
| Fund type (definition) | Short-term | Long-term | Holding period for long-term |
|---|---|---|---|
| Equity-oriented (at least 65% in listed domestic equity, counting the hedged stock of arbitrage positions); STT paid on redemption | 20% (s.111A) | 12.5% above ₹1.25 lakh a year of such gains (s.112A) | more than 12 months |
| Specified mutual fund (more than 65% in debt and money-market instruments, or a FoF with more than 65% in such funds), units bought on or after 1 Apr 2023 | Slab rates whatever the holding period (s.50AA) | none | not applicable |
| Other funds: gold, silver and international FoFs, hybrids with 35–65% equity, debt-fund units bought before 1 Apr 2023 | Slab rates | 12.5%, no indexation | more than 24 months (unlisted units); more than 12 months for listed units such as ETFs |
| Gold and silver ETFs, and other listed ETFs that are neither equity-oriented nor specified funds | Slab rates | 12.5% | more than 12 months |
| Debt ETFs and debt index funds (more than 65% debt) | Slab rates whatever the holding period | none | not applicable |
Sources and status [S]: the equity rates and the ₹1.25 lakh exemption apply to transfers from 23 Jul 2024 (Finance (No. 2) Act, 2024) and were reported unchanged by the Budget of 1 Feb 2026 (M00 · 0.7.2). The definition of a specified mutual fund was changed by the Finance (No. 2) Act, 2024, from "not more than 35% in domestic equity" to "more than 65% in debt and money-market instruments", with effect from assessment year 2026-27 (so for transfers from 1 Apr 2025); this moved gold, silver and international FoFs out of the slab-rate bucket1. The holding periods (12 months for listed securities, 24 months for other assets) were set by the same Act.
6B.11.3Payout options and after-tax returns#
IDCW versus growth A scheme's income distribution cum capital withdrawal (IDCW) option, called the dividend option until SEBI renamed it in 2021, pays out part of the NAV from time to time; the NAV falls by the amount paid. The name is honest: the payout can come from the investor's own capital (the equalisation reserve that new investors pay into). IDCW is taxed as income at slab rates in the investor's hands, with TDS above a threshold (verify the current threshold). The growth option pays nothing and defers all tax to redemption, at capital-gains rates. For a taxable investor in a high slab the growth option dominates: the same cash flow can be produced by redeeming units, which is taxed only on the gain and at lower rates.
Worked example 6B.16arbitrage fund versus liquid fund, after tax
An investor in the 30% slab (31.2% with cess) parks money for 12 months. An arbitrage fund earns 5.4% net of its TER; a liquid fund earns 5.7% net (illustrative, consistent with a repo rate of 5.50%). Held for exactly 12 months, the arbitrage gain is short-term at 20% (20.8% with cess): after tax. The liquid fund's gain is taxed at the slab: . The arbitrage fund wins by 0.36 point a year after tax despite earning less before tax, and by more if held beyond 12 months. For an investor in a low slab, the order reverses. This tax wedge, not any market inefficiency, is why arbitrage funds are large in India.
Practitioner notes
- Check the fund's tax category in the SID before buying: hybrids are designed around the 65% and 35% lines.
- Gold and silver ETFs avoid the 24-month wait that unlisted gold FoFs face for long-term treatment, but carry exchange trading costs (6B.9).
- International FoFs can be closed to fresh money when the overseas limit binds, and their ETFs can trade at premiums (6B.9.3).