Mutual Fund Taxation – How Mutual Funds Are Taxed?

Mutual fund investing is one of the most popular investment methods to accumulate wealth in India. But to maximize returns and avoid any sort of penalties under tax laws, it is important to know how the mutual fund are taxed. Depending on such factors as the type of fund, holding period and the investor’s tax slab, mutual funds have different tax treatments.

Mutual fund taxation has evolved several times over the years with the introduction of Goods and Services Tax (GST) and amendments in tax laws. This guide is about taxation of mutual funds in India it can help you in understanding the several aspects of capital gains and taxation on mutual funds in India (including capital gains taxation, tax rates, and tax-saving tips).

What is Mutual Fund Taxation?

Mutual fund taxation is how the gains and dividends earned from your mutual funds are taxed. The tax liability depends on:

1. Mutual fund category – Equity, Debt, or Hybrid funds
2. Holding period — Short-term or long-term
3. Nature of income – Capital gains or dividend income

This would help investors in making informed decisions as far as mutual funds of different categories are concerned.

Mutual Fund Capital Gains Taxation

Mutual fund capital gains are the income made on the selling of mutual fund units at a higher price than the purchase price the tenure of mutual fund equities would have apparent tax implications on capital gains.

1. How are Equity Mutual Funds Taxed?

Equity mutual funds are those that invest at least 65% of their assets in equity-related instruments. So, the taxation on capital gains for equity mutual funds is as follows:

A) Short Term Capital Gain (STCG)

• Less than 12 months (Holding Period)
• Tax Rate: 15%
• Applicability: If the investor sells the units within a year of purchase, the gains will attract a flat STCG tax of 15%.

B) Tax on Long-Term Capital Gains (LTCG)

• Duration of Holding: Greater than 12 months
• Tax rate: 10% (as long as the profit does not exceed ₹1 lakh in a financial year)
• Applicability: In case if holding period is more than one year amounting to Rs 1 lakh are tax-free. As mentioned earlier, LTCG is taxed at 10% without indexation benefits on any amount above ₹1 lakh.

2. Taxation on Debt Mutual Funds

Debt mutual funds invest mostly in securities like bonds, government securities and treasury bills. Here are the details regarding male taxation of capital gain from debt mutual funds:

Short-Term Capital Gains (STCG)

• Holding Period: Less than 36 months
• Tax Rate: As per the investor’s income tax slab
• Applicability: STCG from debt funds is added to the investor’s total income and taxed according to the applicable income tax slab rate.

Long-Term Capital Gains (LTCG)

• Holding Period: More than 36 months
• Tax Rate: 20% with indexation benefits
• Applicability: LTCG from debt funds is taxed at 20% with indexation benefits, which reduces the tax burden by adjusting for inflation.

3. Taxation on Hybrid Mutual Funds

Hybrid funds, i.e. invest in a mix of equity and debt. The tax treatment depends on the equity exposure:

• If equity exposure is 65% or more – Taxed as equity mutual funds.
• If equity exposure is less than 65% – Taxed as debt mutual funds.

Taxation on Mutual Fund Dividends

Until recently, dividends from mutual funds in the hands of investors were tax-free as the mutual fund house was paying the Dividend Distribution Tax (DDT). According to the Finance Act, 2020 dividend now taxed in the hands of the investor in accordance with the applicable income tax slab of the investor.

How Dividend Income is taxed Now?

• Tax Rate: As per the investor’s income tax slab rate.
• Applicability: The mutual fund house deducts TDS on dividends above ₹5,000 in a financial year at 10%.

This new rule is particularly beneficial for high-income earners who may now be required to pay a higher tax tariff on their dividend income than the dividend distribution tax, which was levied under the previous law.

Mutual Funds Securities Transaction Tax (STT)

In the case of equity-oriented mutual funds, STT is charged at the time of sale:

• STT on Equity Mutual Fund Redemption: 0.001% on redemption (for delivery-based transactions)
• STT on Debt Mutual Funds — N.A.

On transfer of units of mutual fund through stock exchanges, this tax is withheld at source.

Tax-Saving Strategies for Mutual Fund Investors

1. Invest to ELSS (Equity-Linked Savings Scheme)

ELSS is an equity-linked savings scheme type of mutual fund which gives tax benefits under the Income Tax Act’s 80C section. Investors can earn a tax deduction of up to ₹1.5 lakh every year saving taxable income.

• Lock-in Period: 3 years
• Taxation: LTCG is taxed at 10% above ₹1 lakh

2. Give investments time to be rewarded

If you hold mutual fund investments for more than one year (in the case of an equity fund) or three years (in the case of a debt fund).

3. Choose Growth Instead of Dividend Option

That is why choosing the growth option over dividend option for mutual funds helps investors because they will only be taxed when they end up selling the units.

4. Debt Mutual Funds — Indexation Benefit

The gain on investments in debt funds for over three years can benefit from indexation, which adjusts the gain for inflation and lowers the taxable gain.

5. Plan Redemptions Smartly

Investors redeeming mutual funds must do so in a staggered manner keeping in mind the ₹1 lakh LTCG exemption limit to ensure that they do not end up incurring additional tax liability.

Recent Changes in Taxation of Mutual Funds

Over the past few years, the government of India has implemented multiple updates on how mutual funds are tax treated by Indian investors. Among the important amendments are:

• Tax on the Dividends: Dividend are taxable after April 1, 2020, will be deducted in the hands of the investor rather than the mutual fund house.
• Abolition of DDT: Dividend income subject to the individual tax slabs.
• Tax on LTCG on Equity Mutual Funds: Taxation on gains exceeding ₹1 lakh is now 10%.
• E-invoicing and GST on Mutual Fund Services: Mutual fund houses levy 18% of GST for fund management fees.

Conclusion

Taxes on mutual funds in India are dictated by holding periods, fund types and income tax slabs of the investor. The taxability of the capital gains depends on various factors such as the pre-specified holding period (short-term/long-term), liquidity, etc. Mutual funds that invest in the equity market, are more tax favorable compared to those investing in the debt market. Additionally, ELSS funds are a great tax-saving tool under Section 80C.

Hence, investors need to keep themselves updated on the mutual funds tax rules and take sound tax-saving schemes to maximize the returns. Investors can optimize their tax efficiency and wealth growth by strategically planning redemptions, taking advantage of indexation benefits, and selecting appropriate investment avenues.

Taxation changes motivate long-term investment, and mutual funds provide higher return, tax efficiency, financial growth opportunity to long-term investors.

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• GST Return Filing Online
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• Income Tax Return Filing Online