A Comprehensive Guide on Mutual Fund Taxation

Mutual funds are tax-saving instruments. Taxes offered on mutual fund investment primarily depend on the type of fund, investment duration and income tax slab an investor falls under.

Investing in fixed deposits can increase tax liability (if individuals fall under a higher tax bracket) as interest is included in taxable income and taxed as per the applicable tax slab. Here, a mutual fund can offer tax-efficient returns.

Individuals willing to learn about mutual fund taxation and invest accordingly must read the following sections to make an informed investment decision.

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How Can Investors Earn by Investing in Mutual Funds?

When investors invest money in mutual funds, they earn particularly in three ways. These are as follows,

Income from Dividend or Bond Interest Gain

Investors can earn from dividends on shares of stocks and interest on bonds that are included in a portfolio. Investors can choose to receive dividends and earn from them, or else they can reinvest their dividends and earnings to buy more shares.

Capital Gain from Selling Securities

Investors buy units of mutual funds at a particular price. If that price increases in future, investors can choose to sell units and earn capital profit.

Note: Both the income from dividends and capital gains under the mutual fund are taxable.

Increase Price of Mutual Fund Scheme

When the prices of mutual funds increase, and the fund manager decides not to sell them, the prices automatically go up. Here, investors can sell units of mutual funds to make a profit.

How Is Mutual Fund Income Taxed?

There are different types of mutual funds, namely equity funds, debt funds and hybrid funds. These funds are taxed in India differently. Let’s learn about Mutual Fund taxation in detail.

Taxation on Dividends Earned from Mutual Funds

Dividends that the investors get added in the calculation of total taxable income are taxed as per applicable slab rates. This amendment reduces the burden on small investors.

Taxation on Capital Gains Earned from Mutual Funds

Taxation rates of capital gains earned from mutual funds depend on mutual fund type (equity, debt and hybrid) and holding period. The holding period refers to the time between the purchase date of units of a mutual fund and the selling date of the same.

Taxation on Capital Gains Earned from Equity Funds

Equity funds are those mutual funds that primarily invest in equities (at least 65%). Investors can gain short term capital gains (STCG) at a tax rate of 15% (irrespective of the income tax bracket they are all under) if they hold units of equity mutual funds for less than 1 year.

In case of a holding period of more than a year, investors realise long term capital gains (LTCG). If investors sell units after 1 year and gain ₹1 lakh, these are tax-exempt. However, if the gains cross the threshold of ₹1 lakh, it attracts long term capital gains tax at 10% without indexation.

Taxation on Capital Gains Earned from Debt Funds

Debt funds are mutual funds that invest in fixed income securities like bonds, treasury bills etc. Investors can gain short-term capital gains (STCG) tax if they redeem units of debt funds within a period of 36 months. Here, the debt mutual fund taxation will occur according to the applicable income tax slab rate as the total taxable income includes gains from debt funds.

On the other hand, if one sells units of debt funds after a holding period of 36 months, the taxation on long term capital gains (LTCG) will occur at a rate of 20% with indexation. Debt fund taxation will further include cess and surcharge.

Taxation on Capital Gains Earned from Hybrid Funds

The taxation of hybrid funds or balanced fund occurs as per the equity exposure of a portfolio.

If a portfolio has an equity exposure of more than 65%, then the taxation follows similar rules to that equity mutual fund taxation policy.

On the other hand, in case the equity exposure is less than 65%, then the taxation follows similar rules of debt fund taxation policy. In addition, if a hybrid or balanced fund has 50% investment in equity and 50% investment in debt, the taxation rule will follow the debt fund taxation policy.

Taxation of Capital Gains Invested Through SIP

Systematic Investment Plans (SIPs) are investment methods where investors make small investments periodically (weekly, monthly, quarterly, bi-annually, or annually) in a mutual fund scheme.

In case investors sell units of a mutual fund invested through SIP after holding it for more than 1 year, investors can realise long term capital gain (LTCG) on that purchased unit. Here, there is no SIP taxation if the gains do not exceed ₹1 lakh.

On the other hand, investors can start getting short term capital gains (STCG) from the second month onwards. Here, irrespective of income tax slab, investors have to pay 15% tax on these gains, including applicable cess and surcharge. The taxation rules differ in the case of investors investing in mutual funds through Systematic Investment Plans (SIPs).

Fund Type

Short-term Capital Gains

Long-term Capital Gains

Equity Funds

Shorter than 12 months

15% + cess + surcharge

12 months and longer

Up to ₹1 lakh a year is tax-exempt. Any gains above ₹1 lakh are taxed at 10% + cess + surcharge.

Debt Funds

Shorter than 36 months

Taxed at the investor’s income tax slab rate

36 months and longer

20% + cess + surcharge

Hybrid Equity-oriented Funds

Shorter than 12 months

15% + cess + surcharge

12 months and longer

Up to ₹1 lakh a year is tax-exempt. Any gains above ₹1 lakh are taxed at 10% + cess + surcharge.

Hybrid Debt-oriented Funds

Shorter than 36 months

Taxed at the investor’s income tax slab rate

36 months and longer

20% + cess + surcharge

Mutual fund taxation is indeed a complex topic. However, after reading the sections mentioned, understanding the same is not an issue anymore. Now investors can take an informed investment decision as per their investment goals and risk appetite.

Frequently Asked Questions

All

Do investors of the hybrid equity-oriented fund have to pay Securities Transaction Tax (STT)?

Yes, investors who decide to buy or sell the hybrid equity-oriented fund have to pay a Securities Transaction Tax of 0.001%.

Do you have to pay Securities Transaction Tax if you sell a debt fund unit?

No, you do not have to pay Securities Transaction Tax if you sell a debt fund unit.

Frequently Asked Questions

All

Does a mutual fund offer rider benefits?

No, a mutual fund does not offer rider benefits. It is available with mutual funds. A rider is an additional coverage and added protection against risks.

What are the different types of mutual funds?

Different types of mutual funds are Index funds, Balanced funds, Equity funds, Money market funds, funds of funds, and Specialty funds.

What are the different types of life insurance policies?

Different types of life insurance policies are Term insurance plans, Group insurance plans, Life annuity insurance plans (immediate and deferred), Whole life insurance plans, Unit-linked insurance plans, and Endowment plans.