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Mutual Funds Taxation

Mutual Funds! You must have come across this term during T.V. commercials or while reading newspapers. They are thus a highly popular source of investment for people having bigger ambitions. Moreover, they are different from fixed income instruments like a Savings account or a Fixed Deposit. Investors are always curious to find about the Mutual Funds tax scenario in India. In the following analysis, we discuss Mutual Funds taxation in India and their various aspects for the benefit of our readers.

What are Mutual Funds?

Mutual Funds pool money from different investors and invest this money into different schemes as per its objectives. Furthermore, there are a variety of mutual funds like Equity Funds, Bond Funds, Balanced Funds, ELSS, etc. AMC or Asset Management Company runs mutual funds.

Subsequently, the AMC also appoints a fund manager to invest these funds and the investors in achieving their investment goals. SEBI norms define the taxation on these funds. SEBI Regulations and Income Tax Act,1961 govern the mutual funds taxation in India.


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Criteria for Mutual Funds taxation in India

Mutual Funds are the best way to accumulate enough financial resources for the years to come. It is equally important to remember that mutual funds provide earnings. These earnings are in the form of capital gains and dividends.

Also, Capital gains are taxed from the investors while the dividend is taxed as Dividend Distribution Tax (DDT) from the fund-house (AMC) on behalf of the investors. We discuss the details on Capital gains and Dividends vis a vis mutual funds taxation in India, hereby.

1. Mutual Funds Taxation for Capital Gains (FY 2019-2020)

The question is what are Capital Gains and their impact on mutual funds taxation? Capital Gains is thus the difference between the value at which an investor purchased the units of Mutual Fund and the value at which they finally sold it off or redeemed. As an example, Mr. Suresh invested Rs 2 lakh in a mutual fund scheme on April 1, 2010, and the value of his investment on April 1, 2013, was Rs 2.5 lakh. In this instance, he has earned a capital gain of Rs 50,000.

Moreover, the capital gains taxation on mutual funds is dependent on factors like the type of mutual fund scheme and the duration of the investment. Subsequently, on the basis of the duration, there are two types of capital gains levied, namely,

  1. Short-term capital gains or STCG
  2. Long-term capital gains or LTCG

We can thus understand the Short-term capital gains from the table below,

Scheme Particular Short-term capital gains tax Long-term capital gains tax
Equity-oriented
 
 
Duration ≤ 12 months > 12 months
Tax rate 15% 10%
Non-equity oriented
 
 
Duration ≤ 36 months > 36 months
Tax rate As per the income tax slab of the investor. 20% after indexation

*Long-term capital gains are relaxed up to Rs 1 lakh. For example, if your Long-term capital gains for FY 2017-18 is Rs 1.2 lakh, Rs 20,000 will be taxable under the LTCG.

An Example to understand Mutual Funds Taxation

Let’s indeed understand this mutual funds taxation with the help of an example.  Suppose, Mr. Nagesh invested Rs 100 in a debt fund in FY 2014-15 and sold it off for Rs 160 in FY 2017-18. Since Mr. Nagesh sold it after 3 years, the gain is long term. Subsequently, the LTCG tax of 20% indexation is applicable to him.

Now, CII (Cost Inflation Index) for FY2014-15 was 240 and for FY2017-18 was 272. Thus,

272/240 *100 = 113 and his taxable gain will be 160-113 = 47. Therefore, the net tax payable will be 20% of 47 = Rs 9.4 and not Rs 12 (20% of 60).

In the case of capital losses on a mutual fund scheme, they can be thus adjusted against capital gains on mutual funds investment in the same year.

Also, Short-term capital losses can be adjusted against short-term and long long-term capital gains while Long term capital losses can be adjusted against only long-term capital gains.

2. Funds for Dividends Taxation (FY 2020-2021)

Now the question arises, what are dividends? Dividends are basically that part of the profit a company earns and distributes among its investors. Dividend Distribution Tax is a liability that a company has to pay to the government. Also, it is according to the dividend paid to the investors.

As per the FY2019-20, DDT was to be paid by the fund-house to the government and not the investors. A 30% DDT was charged from the fund-houses.

However, as per the budget of FY2020-21, DDT is now to be taxed from the investors and not the fund-house. DDT has been finally abolished. This will thus have a huge impact on the mutual funds taxation in the country. The decision to end DDT has been welcomed across the business sector.

Tax Benefit of Mutual Funds

There are multiple options to choose from in the mutual funds market. Each option has its own set of benefits which can range from deductions under section 80C of the Income Tax Act,1961 for investments up to Rs 1.5 lakh in a financial year.

Such schemes have a greater proportion of equity components. Also called the Equity Linked Savings Scheme(ELSS).

Although the exemptions are for investments up to Rs 1.5 lakh, investors can invest more than this amount for the goal of wealth creation using equity instruments. They can also go for a monthly SIP (Systematic Investment Plans) instead of a lump sum investment.

Furthermore, the investors must be KYC(Know Your Customer) compliant and follow the guidelines. ELSS also has 3 years as a minimum lock-in period(minimum time of investment). Thus, they cannot redeem or switch in between.

Mutual Funds Tax

Types of Holding Periods

Subsequently, there are two kinds of holding periods in relation to mutual funds taxation in India. It is thus vital to understand the kinds of holding period for getting clarity in regards to the mutual funds tax in India. They are,

  • Long-term Holding Period
  • Short-term Holding Period

1. Long-term Holding Period

The holding period of 12 or more than 12 months is considered a long-term holding period while for the debt funds, in contrast, a holding period of more than 36 months is considered a long-term holding period.

2. Short-term Holding Period

For Equity Mutual Funds, a holding period of fewer than 12 months is considered a short-term holding period while for the debt funds, in contrast, a holding period of fewer than 36 months is considered a short-term holding period.

How to Manage Mutual Fund Taxation

Investors must thus follow the following steps to have a great experience while investing in mutual funds.

1. Firstly, ensure that you fully understand the product you are going to invest in and also know the risks associated with such an investment.

2. Secondly, during the cycle of investment, you can stay invested in the scheme without thus falling into taxation liabilities on untimed exits.

3. Thirdly, analyze the funds carefully so that you do not pick an investment that is thus inappropriate.

4. Fourthly, you must remember that every redemption(withdrawing of money from the investment) will be taxable according to the holding period.

5. Lastly, avoid frequently buying and redeeming units in a mutual fund.

Mutual Funds Tax

Conclusion

Mutual fund investments are one of the most attractive options for capital appreciation. There are a wide variety of schemes in the market which you can thus avail. However, Mutual funds taxation in India is subject to holding periods.

Mutual funds attract capital gains tax in India and are of two types, namely, short-term capital gains and long-term capital gains. Your economic goal should be the key factor in making an investment in mutual funds. Furthermore, it is advisable to go through each and every scheme before finalizing the investment.

 

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