Know More about Mutual Funds Taxation

Table of Contents

Mutual funds taxation is the most important topic to know tax on capital gains of mutual funds? These capital gains are often subjected to taxation for which you should be prepared beforehand. Here, we intend to throw light on the various areas of concerns related to mutual fund taxation and how to go about the process in a smooth way. 

1. Holding Period of Mutual Funds

For most investors, the primary intent of making mutual fund investments is related to earning interests or dividends and capital gains. The capital gains attributed to mutual funds are taxed by income tax authorities in accordance to their holding period. In other words, the amount of tax payable on capital gains is dependent on the duration of your ownership in them. This holding period can either be for a short duration or a long duration. 

If you have invested in balanced mutual funds or equity mutual funds then the long-term holding period would amount to a duration of 12 months or more. However, this is not the case with debt mutual funds wherein a duration of 36 months or more is considered as being long-term. Anything less than these periods is termed as short-term holding period for the purpose of taxation. 

2. Mutual Funds Taxation

The equity funds in your possession can be divisible into tax-saving and non-tax saving ones. Take a look at the right ways to deal with them both. 

a. Non-tax Saving Equity Funds

If you have invested in non-tax saving equity funds then the Long-Term Capital Gains (LTCG) will be devoid of taxes to an extent of up to INR 1 lakh. Any LTGC in excess of INR 1 lakh becomes taxable at the rate of 10 per cent without providing you with the benefits of indexation. 

For example, imagine that you have bought shares worth INR 100 on 30th September in the year 2017 and have sold them off on 31st December in the year 2018 at INR 120. On 31st January 2018, the value of your stock happened to be INR 110. Your capital gain is INR 20 (i.e 120-100). Out of the INR 20, INR10 (i.e 110-100) is non-taxable as per IT regulations. The other INR10 is taxable at 10 per cent without indexation. 

As far as the short-term gains are concerned, if the units have been redeemed within 12 months then they become taxable at 15 per cent. 

b. Tax-Saving Equity Funds

The popular Equity-Linked Saving Scheme (ELSS) happens to be the most efficiently designed tax-saving instrument pertaining to Section 80C of the Income Tax Act, 1961. 

These diversified equity funds help you invest in the equity shares belonging to different companies in a wide range of market capitalization. The ELSS presents a lock-in duration of 3 years. This means that any redemption of the units invested in by you can only take place after three years and not before that. By investing in ELSS, you may claim tax deduction amounting to INR 1.5 lakhs to save INR 45,000 worth of taxes. 

Once you decide to redeem the units after the 3 years lock-in period expires, the LTCG amounting to up to INR 1 lakh will be tax-free for you. Any amount exceeding INR 1 lakh in the LTCG will be taxable at10 per cent without providing any benefits of indexation. 

c. Debt Funds

If you are in ownership of debt funds then the LTGC applicable to them will be taxable at 20 per cent after providing the benefits of indexation. Indexation provides a method to prevent your debt funds from draining. It is used to factor the inflation rise in the period between the purchase year of the debt mutual funds and the year when they are released or sold off. This helps in inflating the purchase price of your debt funds with the aim of reducing the capital gains significantly. 

The short-term gains attained from debt funds will be added to your yearly income. These gains are subjected to short-term capital gains tax (SCGT) in line with the income tax applicable to you. 

d. Balanced Funds

The equity-oriented hybrid funds, or balanced funds as they are commonly called, have at least 65 per cent of their ensuing asset value in equities. This is the main reason why the tax calculation and treatment system applicable to them is the same as those applicable to non-tax saving equity funds. 

e. SIPs

A Systematic Investment Plan or SIP refers to the systematic and periodical investments made in mutual funds. A fixed amount is added to the SIP account periodically – either on a yearly, quarterly, fortnightly, or monthly basis. The gains attributed to SIPs are taxable as per the holding period and type of mutual fund in your possession. For taxation purpose, every individual SIP is considered as a fresh investment. The gains on each SIP is taxed separately. 

Say, you initiate an SIP of INR 11,000 in equity funds for a year. All individual SIPs will be treated as fresh investments for the sake of taxation. So, after a year, in case you have decided to redeem the entire amount (investments plus gains), then the gains applicable to you will be taxable. 

Only the profit made on your first SIP will not attract any tax because the said investment would complete one year. The remaining SIPs would attract tax for short-term capital gains. 

Securities Transaction Tax (STT)

In addition to the above, the Securities Transaction Tax (STT) is levied by the company whose funds you are holding. STT of 0.001 per cent is to be levied by the company itself. This tax comes into play when you choose to sell units of any balanced fund or equity fund held by you. The sale of debt fund units is not subjected to STT. 

Important Points to Note – Mutual Funds Taxation

1) If 65 per cent or more of the accumulated corpus of your mutual fund scheme has been invested in equities, then the same will be considered as an equity scheme for taxation purposes. 

2) In case you decide to redeem the equity fund investments in your possession within a year, then the gains or returns will be treated as a short-term capital gain and will be taxable at 15 per cent. Any gains on mutual funds holdings above a year will be referred to as long-term capital gains. 10 per cent tax on gains in excess of INR 1 lakh per year will be applicable on your equity investments. 

3) All dividends attributed to equity mutual funds are added to Investors normal income and tax accordingly 

Look Forward! 

In a nutshell, the longer the holding period of your mutual funds’ investments, the more you gain in terms of long-term capital gains – the rate of which is lower than that applicable on short-term capital gains. Do plan your investment accordingly.