Taxes has always raised eyebrows of peoples and are more concerned about reducing its impact. Taxation on investment reduces the net impact of return on investment. This post discusses mutual funds taxation in detail with focus on Equity Funds Taxation, Debt Funds Taxation, SIP Taxation, Balanced Funds Taxation, Index Funds Taxation , Mutual Fund Dividend Treatment/Taxation and ELSS Taxation.
Unlike interest from Fixed deposit which is taxed according to the income tax slab of the depositor, Tax on Mutual funds is not linked to income tax slab of the investor. They are directly taxed on the capital gains of the investment.
What are Capital Gains
Profit or return from the investment in a Mutual fund is known as capital gains. It is the difference in Selling price and Cost price of the investment. The taxes are levied on the capital gains. There are two types of Capital gain tax:
Short term Capital gain tax (STCG): Investment of less than 1 year in equity oriented fund attracts STCG and for Debt-oriented funds, it is less than 3 years
Long term Capital gain tax (LTCG): Investment period of more than 1 year in equity mutual funds comes under LTCG and for Debt-oriented funds, it is more than 3 years
Equity Funds Taxation
Equity funds invest more than 90% of its asset in equity stocks and 2-5% of asset in cash and cash equivalent to meet the liquidity needs. Investment with more than one year is treated as a long-term investment and less than one year is short term investment.
Tax on return from long-term investment in equity fund is NIL and return from short-term investment are taxed 15% short term capital gain tax under current laws for both Resident Indian and Non-Resident Indian (NRI).
Debt Funds Taxation
Debt funds are taxed differently from equity funds. Any fund with less than 65% of its equity stock comes under the classification Non-equity mutual funds. The holding period of investment up to 3 years are treated as short term investment and for more than 3 years are treated as Long term investment.
Debt funds invest its asset in G-Secs, corporate debt and other money market instrument. Long term return from Debt funds are taxed 20% with the benefit of indexation and short term investment is taxed 10%.
Hybrid Funds Taxation (Balanced and MIPs)
Hybrid funds are those funds which invest in a combination of equity and debt security. Hybrid funds are also known as Balanced Funds. There are two types of Balanced Funds: Equity oriented Balanced fund and Debt oriented Balanced Fund and both have different tax implications.
Tax obligation for the investment in the equity-oriented balanced fund for the period of more than 1 year is NIL and for investment that is redeemed within 1 year of purchase, the gains are taxed short term capital gain tax of 15%.
Taxation for the debt-oriented balanced fund is done as per debt funds. Investment period of less than 3 yrs is treated as short term duration and gains are taxed at 10%. Investment period of more than 3 yrs (long term duration) is taxed at 20% including the benefit of indexation.
Index Funds Taxation
Index Funds are pure equity funds which invest in stocks of Index composition ( NSE and Sensex) and weight age of the index. The tax treatment for Index Funds are similar to equity mutual funds as the holdings of the fund is more than 65% in equity stocks.
ELSS Funds Taxation
The main purpose of Equity Linked Saving Scheme (ELSS) is for tax benefits. The investment made on ELSS is tax exempted under section 80C of Income Tax for the year in which investment has been made up to Rs 1.5 Lakh. Income from dividend and capital appreciation are all tax-free because of its lock in period of three years.
Investments made through Systematic Investment Plan (SIP) is tax-free on the investment of more than 1 year period. Those SIP investment which has not completed a year time till the redemption of investment are taxed short-term capital gains tax of 15%.
Mutual Fund Dividend Taxation
Dividend received on mutual fund investment are tax-free in the hand of investors. The Dividend distribution tax (DDT) is paid by Asset Management companies(AMC) before the payment of dividend to investors.
Dividend distribution tax on equity oriented mutual funds is NIL and dividend declared on debt-oriented mutual funds, the AMCs pays the DDT at the rate of 28.84% inclusive of education cess and surcharge.
For Resident Indians
|Long term Capital Gain Tax||Short term Capital Gain Tax|
|Equity Mutual Funds||Nil||15%|
|Debt Mutual Funds||20% with benefit of indexation||10%|
|Hybrid Mutual Funds:|
20% with benefit of indexation
For Non-Resident Indians (NRI)
|Category||Short Term Gain tax||Long term Gain Tax|
|Units of Non-equity Oriented Scheme||Taxable at normal rates of taxes applicable to the assesse||10% without Indexation OR 20% with indexation, whichever is lower (u/s 112)|
|Units of an Equity Oriented Scheme||Taxable at normal rates of taxes applicable to the assesse||Exempt in case of redemption of units where STT is payable on redemption (u/s 10(38))|
Frequently Asked Question (FAQ)
Q: Does Dividend Reinvestment option attracts tax as I don’t get money in my hand and is reinvested in the MF?
A: Yes, dividends declared by the AMC on a fund, is applicable to DDT rules and in Dividend Reinvestment options the amount reinvested will get impacted by the DDT. Hence, your total value of an investment will be lower than Growth option.
Q. Can I adjust long-term capital loss with another fund which is making a profit?
A. No, you cannot adjust. You have to pay taxes on the capital gains made on the fund and as per Income Tax Act, if income from a particular source is exempt from tax, then loss from such source cannot be adjusted against any other income which is chargeable to tax.
Disclaimer: This post doesn’t constitute a tax advice. Please consult your tax adviser before making a final call on the taxa liability.