Before investing in any type of Mutual Funds it is important to understand Mutual Fund taxation and how mutual funds are taxed. Taxation helps you to calculate post-tax returns on your investments and make redemption decisions to minimise your tax burden.
Taxation of Mutual Funds depends upon its type and your mutual funds holding period. Mutual Funds are Taxed under “Income from Capital Gain” under The Income Tax Act 1961. Under Capital Gain, there are two types of gain Long Term Capital Gain (LTCG) & Short Term Capital Gain (STCG). To decide LTCG or STCG you first need to understand the holding period for different types of mutual funds.
1) Holding Period
Holding Period means the number of days you hold a mutual fund, If you hold a mutual fund for the long term it taxed under Long Term Capital Gain and if you hold for short term it is taxed under Short Term Capital Gain. Now Long Term & Short Term means different for different types of mutual funds. The table below helps to understand different holding period for different types of funds.
|Mutual Fund Type||Long Term||Short Term|
|Equity Mutual Fund||More than 12 Months||Less than 12 Months|
|Debt Mutual Fund||More than 36 Months||Less than 36 Months|
|Hybrid (Equity Oriented)||More than 12 Months||Less than 12 Months|
|Hybrid (Debt Oriented)||More than 36 Months||Less than 36 Months|
Note – Hybrid Equity Oriented Funds are mutual funds with more than 65% Exposure to Equity. Similarly, Hybrid Debt Oriented Funds are equity Exposure less than 65%.
2) Mutual Fund Taxation – Equity Mutual Funds
Equity Funds Includes Equity Oriented Hybrid Fund, ELSS, Index Funds and Any Other Type of Mutual Funds with more than 65% Exposure to Equity. Equity Mutual Funds held for more than 12 months are considered as long term and less than 12 months are considered as short term.
LTCG on Equity Mutual Funds
Long Term Capital Gains are taxed at Flat 10% of the Gain amount, with an exemption of up to Rs.1,00,000.
- Case 1 – Suppose you make an LTCG of Rs.70,000 by selling a fund, then there is no need to pay any tax as you are under the exempted limit of Rs.1,00,000.
- Case 2 – Suppose you make an LTCG of Rs.1,85,000 by selling a fund, then tax at 10% is to be paid on Rs.85,000 (185000-100000) after availing tax exemption. Now your tax payable would be Rs.8500 (85000*10%).
STCG on Equity Mutual Funds
Short Term Capital Gains are taxed at flat 15% on the gain amount with no tax exemption.
- Case 1 – Suppose you make an STCG of Rs.70,000, then the tax would be paid on Rs.70,[email protected]% which comes at Rs.10,500.
- Case 2 – Suppose you make an STCG of Rs.1,85,000 then the tax would be paid on [email protected]% which comes to Rs.27,750.
3) Mutual Fund Taxation – Debt Mutual Funds
Debt Mutual Funds are Mutual Funds that invest money in debt or debt-related securities. Debt Mutual Funds also Includes Liquid Funds.
LTCG on Debt Mutual Funds
Long Term Capital Gains are taxed at 20% of the Gain amount, with indexation benefit on the purchase cost of debt funds.
- Case 1 – If you bought Debt Mutual Funds Worth Rs.1,00,000 in 2nd March’ 15 and Sold them for Rs.1,30,000 on 8th March’2018, so it is an LTCG for Debt funds. Now to Calculate LTCG you need to Subtract Indexed Cost from Sale Proceeds. Indexed Cost of Purchase is Calculated as follows-
=> Original Purchase Cost = Rs.1,00,000/-
=> Year of Purchase = FY 2014-2015
=> Year of Sale = FY 2017-2018
=> Cost Inflation Index (CII) of FY 14-15 = 240
=> Cost Inflation Index (CII) of FY 17-18 = 272
=> Indexed Cost of Purchase = Original Cost * CII of Year of Sale / CII of Year of Purchase
=> Indexed Cost of Purchase = 1,00,000*272/240
=> Indexed Cost of Purchase = Rs.1,13,333.
=> LTCG = Sale of Proceeds – Indexed Cost of Purchase
=> LTCG = 1,30,000 – 1,13,333
=> LTCG = 16,667
=> Tax Payable is 20% of 16,667 which comes to Rs.3333/-
You can read more about Inflation Index on ClearTax Website.
STCG on Debt Mutual Funds
Short Term Capital Gains in Debt Mutual Funds are taxed as per your Tax Slab as stated in The Income Tax Act’ 1961.
4) Mutual Fund Taxation – Dividend Income
Dividend Income is Tax-free in the hands of investor up to Rs.10 lakhs in any given financial year and dividend received above Rs.10 Lakhs are taxed at flat 10% of dividend amount.
Case 1 – You have received Rs.5,65,000 as a dividend in FY 2018-2019. No tax is to be paid as the amount of dividend is under the threshold limit.
Case 2- You have received Rs.12,00,000 as a dividend in FY 2018-2019. A tax of Rs.1,20,000 (12,00,000*10%) is to be paid as the dividend amount is above the threshold limit.
Note – The same tax treatment applies to the dividend received from shares. If you receive a dividend from both shares and mutual funds, then both the dividends need to be added up to decide taxability, if it is below Rs.10 Lakhs then tax-free otherwise tax @10% need to be paid on the total amount.
5) Mutual Fund Taxation – Dividend Reinvestment
When you opt for Dividend Reinvestment option, the same tax treatment of dividend income applies here as well when dividends are reinvested.
When you sell the units you need to first determine the holding period & then apply tax treatment depending upon whether it is equity or debt mutual fund as we have mentioned above.
6) Mutual Fund Taxation – SIP
SIP’s in Mutual fund have the same tax treatment as mentioned above you to have to determine holding period & decide which type of mutual fund to apply its relevant tax treatment.
But you need to make sure to determine holding period correctly as you have invested in a different time frame so there might be a case when some amount of you gain is invested for the long term and some for the short term, it depends upon when you withdraw funds.
7) Mutual Fund Taxation – SWP
SWP Stands for Systematic Withdrawal Plan where you withdraw a fixed amount from your mutual fund every month.
Tax Treatment of SWP is similar to as we discussed as above but for each withdrawal, you need to calculate holding period separately to decide whether it is short term or long term.
Now that we have covered taxation of various types of mutual funds it is important to observe and learn from these tax treatment. As we saw whenever you hold funds for the long term the tax payable is definitely less than the short term. Even while investing in mutual funds it is important to invest for long term for better returns as well as for lower taxes.
Also Read – How to Invest in Mutual Funds in India?