It may be noted that dividend received by unit holders, dividend distribution tax payable by mutual funds, long term capital gain are exempted from tax in case of equity oriented mutual funds. Unlike equity oriented MFs, debt MFs are subject to dividend distribution tax at the rate of 12.5 per cent.
Besides they are subject to tax on long-term capital gains at 20 per cent of capital gain after allowing indexation benefit or at 10 per cent flat without indexation benefit, whichever is less and short term capital gains are subject to tax as per the tax bracket applicable to the investor. Such differential taxation acts as a disincentive for mutual funds investments.