Mutual fund Taxation matter a lot for most mutual fund investors. Taxes paid on your mutual fund investments mainly depends upon the type of schemes you have invested in, the duration of your investment, and the income tax slab you belong to.

Indian Households invest enormous sums of money in Indian and overseas equity markets through mutual funds.

An investor in mutual funds can make the returns broadly in two forms:

Mutual Fund Returns
Mutual Fund Returns

The profits You generated from the Mutual Fund Investments are termed as Capital Gains.

What Is Capital Gain Tax?

Capital gain is the gain obtained by an Investor on the capital invested, i.e., the amount received on sales of securities in excess of the purchasing price. Capital gain tax is a tax that is levied on the gains received at the time of redemption.

This gain or profit comes under the category ‘income’, and hence you will need to pay tax for that amount in the year in which the transaction takes place. This is called capital gains tax, which can be short-term or long-term.

Tax Benefits of Investing in Mutual Funds

Investors often do not think about tax implications when making investment decisions.  Mutual funds are among the most tax-friendly investment options available to investors. An important point to note in mutual fund investments is that the question of tax arises at the time of sale of units of a mutual fund scheme.

If you want to invest in Mutual Funds for tax benefits, Equity Linked Saving Schemes (ELSS) is the way to go. ELSS funds are well-known for the tax-saving benefits along with the superior returns they offer. You can currently enjoy benefits on investments for up to INR 1.5 lakh under Section 80C of the Income Tax Act each year with ELSS.

An investor should note that Rs 1.5 lakhs is the overall 80C limit for all eligible tax-saving products items like employee provident fund (EPF) contribution, PPF, life insurance premiums, NSC and ELSS mutual funds, etc.

By investing in ELSS, you can get the dual benefits of investment growth as well as tax savings.

Despite the tax applicable on mutual fund returns, there are still plenty of opportunities to get mutual fund tax benefits if one invests smartly. So, if you’re looking to invest money and want a tax-saving option, then mutual funds are the best way to go.

 What is Equity Mutual Fund

In any mutual fund Scheme, if more than 65% of the corpus is invested in equities, then these schemes are treated as equity schemes from the perspective of taxation.

Equity Mutual Fund Taxation

  Short term Capital Gain Long term Capital Gain
Period Up to 12 Months More Than 12 Months
Tax Rate 15% 10%

 

In equity mutual Funds when the Investments holding period is less than 12 months then they’re treated as Short Term Investments and when it’s over 12 months they are treated as Long Term Investments.

Short Term Capital Gains in equity Funds are taxed at 15%. Whereas, Long Term Capital Gains in equity capital is taxed at 10%.

What is Debt Mutual Fund

In any mutual fund scheme, if less than 65 percent of the corpus is invested in stocks, then these schemes are treated as debt strategies in the perspective of taxation.

Debt Mutual Fund Taxation

  Short term Capital Gain Long term Capital Gain
Period Up to 36 Months More Than 36 Months
Tax Rate Income Tax Slab Rate of Investor 20% after indexation

 

In debt mutual fund if the investment holding period is less than 36 months they’re treated as Short Term Investments and when it’s more than 36 months they’re treated as Long Term Investments.

Short Term Capital gains in Debt Mutual funds are taxed in accordance with your income tax slab. Whereas, Long Term Capital Gains in Debt Mutual Funds are taxed at 20% after indexation.

The longer you hold your mutual fund units, the more tax-efficient they become as the taxation on long-term gains is much lesser than the tax on short-term gains.

Taxation of Dividends Offered by Mutual Funds

According to the amendments made from the budget 2020, dividends offered by a mutual fund is taxable in the hands of the investor. In other words, dividends received by all investors have been added to their income and taxed at their respective income tax slab prices.

The Finance Act, 2020 also imposes a TDS on dividend distribution by mutual funds on or after 1 April 2020. The standard rate of TDS is 10% on dividend income paid in excess of Rs 5,000 from a mutual fund.

The new mutual Fund’s dividend taxation principles have made dividend strategies less attractive. This shift will boost the sales of growth and SWP option strategies.

Earlier, dividends were made tax-free in the hand of investors as the fund house paid dividends distribution tax (DDT) prior to sharing their profits with investors in the form of dividends.

Securities Transaction Tax (STT)

Apart from the taxation on dividends and capital gains, there’s another tax known as the Securities Transaction Tax (STT). An STT of 0.001 percent is levied by the government on every sale and purchase of an equity mutual fund.

If you’ve invested in a debt mutual fund, then no STT is liable on it. So, the next time you want to invest in the market, keep STT in mind.

Taxation of Mutual Funds Some Important Points to Keep in Mind

Before we proceed to conclude, we wanted to incorporate several essential points to remember in regards to taxes paid to your mutual fund investments.

If you are investing in mutual funds by means of a systematic investment plan (SIP), it is essential to keep in mind that each SIP is considered an individual investment.

And, if you decided to redeem your investment following 12 months of SIP investment, then all your profits would not be considered LTCG for taxation. Only the first SIP will be treated LTCG as only that investment has completed one year. The rest of the profits will be subject to short-term capital gains taxation.

It is also important to remember that tax is collected on the whole value of redeemed funds rather than individual funds. If, for instance, the profits from your entire portfolio exceed Rs. 1 lakh, only then will your income be subject to LTCG of 10%.

It might help if you’re able to avoid frequent purchases and redemption of mutual fund units. Each redemption will be treated as a withdrawal and will be taxed as per the holding period. This is just an unnecessary expense that can be easily avoided.

Your entire Investment plan should revolve around your financial goals. Any of those investments which don’t align with your goals should ideally be redeemed promptly and moved into funds that could serve your financial goals better.

Conclusion

I hope you enjoyed reading Mutual Fund Taxation and found it helpful. You finally understand that the capital gains received on both equity and debt funds aren’t tax-free. On the other hand, the dividend received is added to your income and taxed accordingly. Even though the capital gains are taxable, the returns generated by these are higher compared to conventional investment products. Thus, making them an investor’s beloved investment choice.

If you’ve any further questions, please feel free to navigate through our blog. We try our best to supply as much advice as possible by discussing many relevant topics that can assist you in making the right investment decision.

Please also read: Liquid Funds: Top 5 liquid Funds to invest in India: 2021

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8 COMMENTS

  1. Hi Sunil, again simple and crystal clear thoughts in layman’s language.
    Keep rocking stock world website with such insightful blogs.
    So, what is your advice for mutual funds not invested with re-investment option. In trading account it is seen as redemption and repurchase every month. It is advisable to continue in such scheme or exit should be the strategy.

    • Hi Ranjan,

      Thanks for your opinion about the article. Reinvestment option is not advisable as it will incur additional expenses i.e STT and other transactional charges. If it redeems within a year it will also attract short-term capital gain. Other than this monitoring of funds will also be very difficult.
      My suggestion to go with the growth option.

      Regards
      Sunil Kumar

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