Taxation on Mutual Funds

04 Oct, 2021

6 min read

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Mutual funds are widely regarded as an important investment option since they help you achieve your financial goals. They are tax-efficient investment vehicles, read on to understand how taxation works on mutual funds.

Introduction

Mutual funds are known to be prudent investments. That being said, understanding the tax implications that govern them is important such that you know how much of the income you earn via them is taxable. Read on to understand the finer details pertaining to tax on mutual funds.

Mutual Fund Taxation

Mutual fund investments can accrue two forms of income. These can be in the form of dividends as well as capital gains (or losses) at the time of sale. Each of these has different tax implications. The type of mutual fund scheme invested in, whether or not it is equity and the time frame for which said investment is held each impact the taxes applicable to it.

Taxes on Dividend Income

Keeping in mind the budget of the previous year, dividends are now considered to be a form of income and are taxed keeping in mind the income tax slab applicable to an investor and the number of units of the mutual fund held by them. 

Furthermore, in line with existing rules, mutual funds are expected to pay DDT or dividend distribution tax on dividends declared by the fund houses.

Presently, equity focused schemes, which funnel over 65 percent of their investments towards equities are liable to pay DDT amounting to 10 percent in addition to a 12 percent surcharge, and 4 percent cess. This ultimately amounts to a 11.648 percent DDT for all forms of investors i.e., investors who are Indian residents, NRIs and domestic companies.

Taxes on Capital Gain in Case of Equity Funds

Capital gains are used to refer to the profits accrued via the sale of mutual fund investments.

In the case of equity focused schemes, should investors hold such investments for a period of 12 months or less, they are classified as short-term investments and short-term capital gain therefore is taxable at 15 percent.

Should these investments be held for a period longer than 12 months, the profits generated on the same are referred to as long-term capital gains (or LTCG). LTCG have a 20 percent tax levied on them in the event that the LTCG in its entirety for a single year exceeds INR 1 Lakh.

Taxes on Capital Gain in Case of Non-Equity Funds

When considering non-equity focused mutual fund schemes, should investments be held for a period of 36 months or less, profits derived from the same are termed short-term capital gains. These short-term capital gains have a 20 percent tax levied on them.

Should these investments be held for a period greater than 36 months, they are considered to be long-term capital gains. These LTCGs are taxed at the highest tax slab that is appropriate for the investor under consideration.

Benefit of Indexation

The term indexation is used to refer to the recalculation of the purchase price. This is done by making adjustments keeping in mind inflation as published by India’s income tax spearheads. Owing to the fact that the purchase price is adjusted keeping in mind inflation, capital gains diminish in their value.

Those who accrue LTCGs on non-equity oriented mutual fund schemes can avail of indexation benefits.

Features Worth Noting

It is important to understand that investments amounting to up to INR 1.5 Lakhs linked to notified equity linked savings schemes are eligible to avail of tax deductions as per Section 80C of the Income Tax Act of 1961. That being said, a 3 year lock-in period is applicable to these.

When considering systematic investment plans (or SIPs), each instalment of the plan is viewed as an individual investment and the holding period is considered to commence from the date of said investments.

Conclusion

Understanding how mutual funds are taxed is of paramount importance as it allows you to anticipate what money you will ultimately be left with following taxation.

To learn more about mutual fund investments visit Angel One’s Smart Money portal today.

Frequently Asked Questions

Q1. What does LTCG stand for?
A1. LTCG is used to refer to long-term capital gains.

Q2. What are the two forms of payments offered by mutual funds?
A2. Mutual funds disburse payments in the form of dividends and capital gains (or losses) at the time of sale.

Q3. What does the acronym DDT stand for?
A3. DDT is used to refer to dividend distribution tax.

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