Mutual Funds Taxation – Know about Tax on Mutual Funds

We all make investments with an aim to enjoy capital appreciation and build a huge corpus in the long run. Mutual funds are one such investment channel that has the potential to offer capital appreciation in the long term horizon. Therefore, you must have always heard financial advisors suggesting the importance of investing in mutual funds. In fact, mutual fund investment is a great way to begin your investment journey.

While we carefully plan our investments, one aspect which is often ignored is mutual fund taxation. Mutual fund taxation rules can get slightly confusing for a layman. However, if you have a mutual fund portfolio, it is imperative that you have a good understanding of how your returns will be taxed.

Tax on mutual funds majorly depends on factors such as the type of fund you have invested in, your investment duration, your income tax slab and so on. This article helps you understand the taxation rules for mutual funds and how mutual fund taxation impacts your overall returns.

Mutual Fund Taxation

When you invest in mutual funds, you make profits in the capital investment in two ways – through capital appreciation and dividend receipts. The mutual fund house or Asset Management Company declares dividends on the equity funds appreciation and dividend receipts. The fund house declares dividends in the event of equity funds as and when the fund makes earnings. Likewise, on debt funds, you receive regular interest at a set rate. With these earnings, the value of your mutual fund investment continues to grow. At the same time, it attracts capital gains that tend to be taxable to investors.

Understanding Capital Gain on Mutual Fund

Capital gain is nothing but the profit that you make on your mutual fund investment when you redeem or sell your mutual fund units. In simple words, it is the difference between the value at which you purchased the mutual fund units and the value at which you are going to sell or redeem them.

For example, let us say, Mr. Rohan invested Rs. 2 lakh in a mutual fund scheme on 1st January 2017 and the value of his investment on 1st January 2020 is Rs. 2.5 lakh. In this case, Mr. Rohan has earned a capital gain of Rs. 50,000.

Taxation of Capital Gain on Mutual Fund

The capital gains tax on mutual funds depends on the type of mutual fund scheme and the investment duration.

The duration over which an investor stays invested in a mutual fund scheme is called the holding period. It plays a crucial role in determining the tax implication on the mutual fund investment. Depending upon the holding period, capital gains tax can be classified into two types – Short term capital gains tax (STCG) and long term capital gains tax (LTCG).

Short-Term Holding Period

Equity funds and equity-oriented hybrid funds are taxable for the short term if the holding period is less than 12 months. On the other hand, debt-oriented hybrid funds and debt funds are taxable as short term if the holding period is less than 36 months.

Long-Term Holding Period

Holding equity funds or equity-oriented funds for more than 12 months is termed as long term. But in the case of debt funds, the investment is termed as long term only if the holding period is 36 months or more.

If the mutual fund is a hybrid equity oriented fund where the exposure of equity is more than 65%, it will be considered as an equity fund for mutual fund taxation. However, when the exposure of the hybrid fund is less than 65% towards equity or it is 50% debt and 50% equity, in such case, the fund shall be considered as debt fund for taxation purpose.

Let us now learn about mutual fund taxation rates.

• Mutual Fund Taxation Rates
• Equity Oriented Mutual Fund Schemes

The mutual fund taxation rates for equity-oriented schemes with a holding period of up to 12 months are taxable for short term capital gains at the rate of 15%. If the holding period is more than 12 months, the long term taxation rate is 10%. The long term capital gains are exempt up to Rs. 1 lakh per annum for investing in equity-oriented mutual funds.

Non-Equity Oriented Schemes

The mutual fund taxation rates for non-equity oriented schemes with a holding period of up to 36 months are taxable for short term capital gains at the rate of investor’s tax slab. If the holding period is more than 36 months, the long term taxation rate is 20% after indexation.

Apart from the above-mentioned capital gains rates, the investor now has to pay tax on the dividend income as per his personal income tax slab rate. Prior to the budget 2020, the fund house (Asset Management Company) was supposed to to pay Dividend Distribution Tax (DDT) on the dividends on mutual funds on behalf of the investors. Another type of tax known as Securities Transaction Tax (STT) is applicable on the sale of mutual fund units in balanced and equity funds. It is applicable to both close-ended and open-ended schemes.

Conclusion

Since taxes take away a major portion of your corpus that you need to meet your financial goals, it is important that you include the tax on mutual funds in your calculation while doing financial planning. Investing in mutual funds is an art and you will master it with time. While deciding to invest, you must consider a few factors such as your investment goals, risk appetite, investment horizon and returns expectation before making any decision.

Acquiring knowledge about mutual funds can help you go a long way. You can read from the vast information available on the internet or you can seek expert advice. If you need any assistance regarding mutual fund investment or taxation on mutual funds, you can contact IndiaNivesh.

Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.