Tax on Mutual Funds

Mutual funds can be one of the preferred investment options for you as they can help in reaching your financial goals. There are some mutual funds schemes under the Equity Linked Savings Scheme (ELSS) in which investments allow an investor tax saving. However, before investing in any mutual fund schemes you must consider factors like liquidity, risks arising out of market movements, lock-in, exit loads and taxation, etc.

Read on to learn more about taxes on mutual funds.

Just like the majority of other investments in various asset classes, mutual fund gains and profits are also taxable. So, before investing in mutual funds, you must know about the guidelines on taxation.

Take a look below mentioned factors to understand income tax on mutual funds:

1. Fund types

Mutual funds are divided into two groups to levy tax on them:

• Equity-oriented mutual funds

• Debt-oriented mutual funds

So, you must first consider the type of the mutual fund you are investing in.

2. Dividend

A dividend is a piece of accumulated profits that the mutual fund house distributes amongst the investors in the scheme. You do not need to sell your mutual fund units to receive dividend on them.

As per new tax rules, the mutual fund house must deduct 10% TDS if the total dividend you receive in a financial year exceeds INR 5,000.

Explanation: Taxation on dividends

As per the latest law governing taxation on dividends, your entire dividend income is taxable as per the income tax slab under the head ‘income from other sources’. TDS is applicable on the dividend distributed by the mutual fund houses. [BR6] [n7] 

3. Holding period of investor

The tax to paid on your capital gains is dependent on the holding period of investment.

The duration of long-term capital gains for equity-oriented mutual funds must be more than 12 months and for debt-oriented mutual funds it must be at more than 36 months.

The duration of short-term capital gains for equity oriented mutual funds is less than 12 months and for debt oriented mutual funds it is less than 36 months.

Also, ELSS comes with a three-year lock-in period. The money you invest in an ELSS is tax deductible up to INR 1.5 lakh.

4. Capital gains

When you sell mutual funds for more money than for what you bought it, you make capital gain. Capital gains are taxed at rates depending upon the type of mutual fund and the holding period of investment.

1. Capital gain on debt schemes

The tax on long term capital gains on debt mutual funds is charged at 20% with indexation benefits and the tax on short term capital gains on debt mutual fund schemes is charged as per your income tax slab. Indexation benefits make debt mutual fund schemes tax efficient by adjusting the purchase cost for inflation.

1. Capital gain on equity schemes

The tax on long term capital gains on equity oriented mutual funds is charged at 10% and there is no benefit of indexation provided and the tax on short-term capital gains is charged at 15%.

Note: Your overall long-term capital gains on equity-oriented schemes up to INR 1 lakh are tax exempt.

The taxes on mutual funds are not as complicated as you may think. Mutual fund taxation essentially depends on your holding period and the type of mutual fund scheme you have invested in. So, consider these two aspects for sure before planning your mutual fund investments to make the most out of your investments.

Disclaimer:

This blog has been prepared to provide the readers with general information and basic understanding of mutual fund taxation.

Before taking any decisions, please consult your tax advisors.