Mutual Funds Taxation – How Mutual Funds Are Taxed?

Mutual Funds

Published on May 22nd, 2020

In India, various types of investment options are gaining popularity rapidly as a large number of investors are keeping lump sum amounts to get good returns.

Earlier, mutual fund investments were not considered convenient by many investors because the returns from it are not guaranteed.

Mutual fund returns have a prominent chance of depreciating due to the situation of market risks.

However, investors in India now have become more aware of the various ways how the returns can be balanced in the right manner.

There are numerous mutual funds available in the country where you can invest directly or at the presence of a mutual fund pilot.

The mutual fund investments are made by several investors at a time that forms a money pool. One can invest in different asset classes like debt, gold, equity, foreign securities, etc.

Returns of the mutual fund investment are taxable as per the guidelines of the Income Tax Act (1961).

Investors can enjoy some tax benefits on mutual fund investments. While investing in mutual funds, investors must have all information about mutual fund taxation.

How Different Types Of Mutual Fund Investments Are Taxed

Different mutual funds come with different features. Taxation is considered as an important factor as it affects the returns of the funds. Below is a detailed analysis of income tax on mutual funds.

Taxation Of Equity Funds

There are three types of equity funds on which mutual fund investments take place which are tax-saver equity funds, regular equity funds, and equity-linked saving scheme funds (ELSS).

For the tax-saver and standard equity funds, the taxation process remains the same.

In these equity funds, a 10% LTCG tax is levied on the capital gains exceeding Rs. 1 Lakh annually.

The indexation benefit is not available for the equity funds. In the case of the ELSS funds, the taxation procedure is the same; however, it has a lock-in period of three years.

So, an investor is restricted to redeem the fund before the lock-in period ends.

Taxation Of Balanced Funds

The equity exposure plays an important role when it comes to the taxation of balanced funds.

The taxation process for the hybrid equity-oriented funds depends on its equity exposure.

In case, the equity exposure is higher than 65%, the hybrid equity-oriented fund will be considered as an equity fund and taxed accordingly.

On the other hand, if the equity exposure is below 65%, it will be considered as a debt fund during taxation.

In case if the equity and debt instruments are present in the hybrid fund in equal halves, it will also be considered as debt funds.

Taxation Of Debt Funds

An investor can avail the convenience of indexation in case of investing in a debt fund.

It helps in saving a decent amount as tax benefits against the investment. It minimizes the quantum of capital gains as the purchase price inflates. The capital gains on debt funds can either be long-term or short- term.

Taxation on the long-term capital takes place at a rate of 20% after the indexation is done. Simultaneously, for the short term capital gains taxes will be levied as the income tax slab which the investor falls in.

Taxation Of Systematic Investment Plans (SIP)

The Systematic Investment Plan setup allows an investor to invest small amounts in the mutual fund periodically.

Here, an investor can enjoy full liberty to pick a specific frequency in which he will deposit the money for investment. One can opt for a weekly, quarterly, monthly, annual, or bi-annual basis.

The taxation of SIP investments varies with the modes of investment. The pro-rata basis is followed to determine the taxes on SIP investments.

An investor needs to be aware that every SIP investment is considered as a new one and taxes are separately charged on them.

Suppose a SIP investment is initiated with Rs. 10,000 in an equity fund for a tenure of 12 months.

Taxes will be levied on each gain that has not completed one year. Only the gains for the first deposit that has already completed a complete year will be tax-free.

Securities Transaction Tax

The Securities Transaction Tax (STT) is levied by the Ministry of Finance (Government of India) when an investor opts for selling units of hybrid and equity funds of investment.

A minute percentage of 0.001% is levied on the capital gains at the time of selling. In case of selling the units of debt funds, no STT is levied in case of debt fund units.

Tax Benefits On Mutual Funds

Apart from the procedure of taxation, it is vital for investors to know about the tax benefits related to mutual fund investment.

For equity mutual funds, the long-term capital gains are free of tax when the principal amount is below Rs. 1 Lakh.

Moreover, an investor can get a tax benefit when holding a debt fund as the dividend distribution tax is given by the fund house at 29% approximately.

Apart from these, the mutual fund tax benefits under Section 80C can be availed. ELSS investments are subject to tax benefits as per the guidelines of the Income Tax Act of 1961.

If an investor invests up to Rs. 1.5 lakhs, he is eligible to avail of the tax deduction.

If you are a taxpayer of the highest bracket (30%), try to invest in ELSS accounts as it can help you to save a good amount of money.

When investing in the ELSS funds, be aware of the fact that the cap of Rs 1.5 lakhs includes the employee provident fund contributions, premiums of life insurance, etc.

Knowing all the income tax rules on mutual funds can help an investor to manage investments easily.

Taxation on mutual fund returns is levied by the government as it works as one of the vital sources of revenue.

Along with this, income tax on mutual funds in India is also imposed. One can determine the right mutual fund investment plan considering the ways it is taxed. In India, there are multiple mutual fund investment options available.

Investors chose a particular fund based on their investment goals. While selecting the right mutual fund, one should analyze all the influencing factors of mutual funds including taxation.