In the past few years, mutual funds have been gaining traction and are gradually becoming a sought after investment vehicle for Indians. However, it is important to understand the tax implications of mutual funds, in order to strike a balance between effective tax saving and maximising returns from investments.
A. Factors that impact taxation of mutual funds
1. Type of Fund:
Taxation of mutual funds differs, depending on its type. Mutual funds can be
broadly classified into the following:
Equity Mutual Funds: Equity mutual funds are the ones which invest at least 65% of the scheme’s assets in equity and equity related instruments.
Debt Mutual Funds: Debt mutual funds are the ones which invest at least 65% of the scheme’s assets in debt and debt related instruments. Debt related instruments include fixed income instruments, such as Corporate and Government Bonds, corporate debt securities, and money market instruments etc. that offer capital appreciation.
Hybrid Mutual Funds: Hybrid mutual funds are those that invest in a combination of equity and debt instruments.
2. Type of Gain:
Mutual fund gains are broadly classified into the following:
Dividend: Dividends are a portion of the profits earned by the mutual fund, which are distributed among the investors. Dividends from mutual funds are taxed at the investor’s slab rate.
Capital Gain: It is the profit that investors earn from selling their mutual fund units at a higher price than the purchase price. Capital Gains are subject to taxes in India and the rate depends upon the type of mutual fund and the holding period.
3. Holding Period:
Holding period implies the period for which an investor holds the mutual fund
units, before selling them. The holding period for mutual funds can be categorized
as either long term or short term. However, it is important to note that the
categorization into long term and short term is different for different types of
funds. This classification can be summed up as under:
Particulars | Equity Fund | Hybrid (Equity Oriented) | Debt Fund | Hybrid (Debt Oriented) |
Short Term | Less than 12 months | Less than 12 months | Less than 36 months | Less than 36 months |
Long Term | 12 months or above | 12 months or above | 36 months or above | 36 months or above |
B. Taxation of Dividend:
Prior to April 1, 2020, mutual fund houses were required to deduct a dividend distribution tax (DDT) of 10% plus applicable surcharge and cess before distributing dividends to investors. However, from April 1, 2020, dividend income from mutual funds is taxable in the hands of the investor.
The tax rate on dividend income from mutual funds depends on the investor’s tax bracket. Dividend income from mutual funds is added to the investor’s total income for the year, and the applicable tax rate is applied to the total income.
C. Taxation of Capital Gains:
1. In case of Equity Funds/ Hybrid (Equity Oriented Funds)
Capital gains arising from equity funds or hybrid (equity oriented) funds are taxed
at special rates depending on their period of holding.
Short Term Capital Gain: If an investor sells his equity mutual fund holdings, within 12 months of purchase, any gains arising from such sale shall be taxed at the rate of 15% plus applicable surcharge and cess.
Long Term Capital Gain: If an investor sells his equity mutual fund holdings, after 12 months of purchase, any gains arising from such sale, in excess of ₹1,00,000 shall be taxed at the rate of 10% plus applicable surcharge and cess.
Capital Gain | Applicable tax rate |
Short Term Capital Gain | 15% + surcharge + cess |
Long Term Capital Gain | Gains above ₹1,00,000 is charged to tax at 10% + surcharge + cess |
2. In case of Debt Funds/ Hybrid (Debt Oriented Funds)
Capital gains arising from debt funds or hybrid (debt oriented) funds are taxed
at tax rates applicable to the investor,i.e:
Short Term Capital Gain: If an investor sells his debt mutual fund holdings, within 36 months of purchase, any gains arising from such sale shall be taxed at the tax rate applicable to the investor.
Long Term Capital Gain: If an investor sells his debt mutual fund holdings, after 36 months of purchase, any gains arising from such sale shall be taxed at the tax rate applicable to the investor.
Tip: However, any long term capital gains arising out of investments made in debt
mutual funds prior to 1 April 2023, shall be taxed at 20% and shall remain eligible
to claim indexation benefits.
D. Tax Benefits of Equity Linked Saving Scheme (ELSS):
Equity Linked Saving Scheme (ELSS) are mutual funds that primarily invest in equity
and equity related instruments and have a lock-in period of 3 years.
Investment in ELSS funds are eligible to a deduction of upto ₹1,50,000 under
section 80C of the Income Tax Act,1961. However, this tax benefit is only available
to the investors who opt for the old tax regime, since deductions under section 80C
are not permissible under the new tax regime.
E. Conclusion
Investment in mutual funds can help investors achieve desired returns whilst
ensuring effective tax saving. Hence, it is important for an investor to choose the
right fund, keeping in mind their investment objectives, tenure of investment, risk
appetite and the applicable income tax rates.
Get your taxes and investment portfolio analysed by experts, to earn high tax
efficient returns from your investments. Contact True Funds today!
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