Taxation of Mutual Funds
According to the Securities and Exchange Board of India (SEBI), a mutual fund is defined as a scheme that collects money from investors, invests it in a portfolio of securities and then distributes the profits back to the investors. Mutual funds have gained popularity as a mode of investment since they offer diversification and professional management of funds.
Mutual funds are subject to taxation in India, with the tax liabilities varying based on the type of funds, the holding period and the tax bracket of the investor.
We will discuss the taxation of mutual fund returns in detail in this article:
Capital Gain Tax:
The tax liability of mutual funds in India is divided into two categories based on the time frame, namely; short-term capital gains tax (STCG) and long-term capital gains tax (LTCG).
The table below describes the tenure that would determine if your tax liability is STCG or LTCG depending on different fund types:
| Tax Tenure | ||
|---|---|---|
|
Fund Type |
STCG |
LTCG |
|
Equity Funds
|
Less than 12 months
|
More than 12 months
|
|
Debt Funds
|
Less than 36 months
|
More than 36 months
|
|
Hybrid Funds (Equity Oriented)
|
Less than 12 months
|
More than 12 months
|
|
Hybrid Funds (Debt Oriented)
|
Less than 36 months
|
More than 36 months
|
Equity Funds:
LTCG: Tax rate of 10% if the gains exceed Rs. 1 lakh without the indexation benefits.
STCG: Tax rate of 15% flat, irrespective of investor’s income tax slab.
Debt Funds:
LTCG: Tax rate of 20% with indexation benefits.
STCG: Tax rate is subject to the investor’s income tax slab rate.
Hybrid Funds:
Equity Oriented Schemes: Tax rates are same as Equity Funds
Debt Oriented Schemes: Tax rates are same as Debt Funds
Dividend Distribution Tax:
Further, mutual funds are also subject to Dividend Distribution Tax (DDT). This tax is applicable when the mutual fund company distributes dividends to the investors.
As per the Finance Act of 2020, dividends are taxed as per the investor’s income tax slab rate and should be shown under the ‘Income from Other Sources’
Note that, u/s 194K, TDS of 10% on dividends is deducted if the investor’s total dividend receivables is more than ₹ 5000, which can be claimed while filing your taxes.
Securities Transaction Tax:
Securities Transaction Tax is charged at the time of buying or selling of mutual fund units. As per the latest regulations, STT of 0.001% is charged on all equity funds and equity oriented hybrid funds. Whereas, the debt funds are exempt from these taxes.
Tax Benefits:
Investments made by individuals and HUFs in ELSS schemes are eligible for tax deductions under the Section 80C of Income Tax Act. Where, these funds have a lock-in of 3 years.
For example – If you fall under the tax bracket of 30%, then in a year you can save taxes of up to ₹46,800 by investing ₹1,50,000 in ELSS Schemes. (₹1,50,000 X 30% = ₹46,800)
On redemption of units after the lock-in of 3 years, Long term Capital Gain (LTCG) is taxed at 10% on the gains exceeding ₹ 1 lakh without indexation.
Conclusion:
Before investing in mutual funds, it is essential for investors to have a clear understanding of the taxes charged on the mutual fund returns. Investors must consider factors such as the expected holding period, the type of mutual fund and the investor’s income tax slab rate to determine the most tax-efficient investment option.
Investors must weigh the expected tax liabilities while investing in mutual funds to maximize returns while minimizing their tax liabilities. Steadfast attention to taxation, combined with astute financial planning will help investors make the most of their mutual fund investments.
