Taxation in Mutual Funds: Mutual Fund Tax Calculation
Tax on mutual funds is paid against the profits earned through investment in equity and debt schemes. In the case of equity funds, tax is levied on the capital gains whereas, the same is calculated on dividends earned, in the case of debt funds.
However, before diving into the details of mutual fund taxation, first, let’s understand how these schemes deliver returns.
Process of Income Generation via Mutual Funds
Mutual fund investments are available in two forms – capital gains and dividends.
- Capital gains: Capital gain is the profit you receive if you sell your mutual fund units at a price higher than you bought them for. A point to note here is that capital gains are taxed depending on the holding period of the mutual fund units.
- Dividends: Dividends are paid to investors who hold mutual fund units that invest in interest-bearing or dividend-paying securities (stocks, bonds, etc.).
Taxation of Mutual Fund Dividends
Following the amendment approved in the Union Budget 2020, the applicability of income tax on mutual funds has changed.
Currently, dividends are taxed in two steps:
- A TDS (Tax Deduction at Source) of 10% is applicable if the dividend income exceeds Rs. 5000. For instance, if an individual receives Rs. 8000 as dividend from an Indian company in September 2021, the company will deduct Rs. 800 as TDS. Resultantly, his dividend income will be Rs. 7200.
- The amount received after TDS will be taxed as per an investor’s income slab. In the above example, Rs. 7200 is taxed as per the applicable rate on the individual’s total income.
Before April 2020, dividends of up to Rs. 10 lakhs in a year used to be tax-free at the hand of investors because companies used to bear DDT or Dividend Distribution Tax.
Taxation on Capital Gains from Mutual Funds
Capital gains on mutual funds are taxed depending on the subtype and holding period of respective schemes.
Here, the holding period refers to the duration one remains invested in a mutual fund. It signifies the period between the purchase and selling of a mutual fund.
Moreover, the taxability of mutual funds here also depends on their type. Here is a table on capital gains for further clarification –
| Type of Fund | Short-Term Capital Gain (STCG) | Rate of Taxation | Long-Term Capital Gain (LTCG) | Rate of Taxation |
| Equity funds | Less than 1 year | 15% + cess + surcharge | 1 year or longer | (10% + cess + surcharge) for capital gains above Rs. 1 lakh |
| Debt funds | Less than 3 years | As per your IT slab rate | 3 years or more | 20% + cess + surcharge |
| Hybrid equity funds | Less than 1 year | 15% + cess + surcharge | 1 year or longer | (10% + cess + surcharge) for returns above Rs. 1 lakh |
| Hybrid debt funds | Less than 3 years | As per your IT slab rate | 3 years or more | 20% + cess + surcharge |
Read on to know more about capital gain tax on mutual funds of different types.
Capital Gains Tax on Equity Funds
Equity mutual funds are those schemes that primarily comprise equity or equity-related investments (>65%). Equity mutual funds are popular for their high returns and are also more exposed to market ups and downs.
Now, if you cash in on your equity mutual funds within a year, you are liable to pay tax on mutual funds at a rate of 15% along with cess and surcharge. Whereas, if you decide to sell your investment after 12 months, then taxes will be levied as –
- Up to Rs. 1 lakh, it remains tax-free.
- Above Rs. 1 lakh, it is 10% without any indexation benefit along with cess and surcharge.
Note: Indexation here refers to the adjustment in the purchase price of investment by factoring in the effects of inflation.
In this regard, investors must remember that index funds too are taxed as per the above-mentioned regime. For instance, if you invest in the Navi Nifty 50 Index Fund, you will need to bear the above tax liabilities.
Similarly, one should know about debt mutual funds taxation.
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Capital Gains Tax on Debt Funds
Debt funds are also known as income funds, and they mainly invest in government and corporate bonds, and securities. Debt funds are classified based on the types of securities they hold, such as short-term, long-term, etc. These also offer better security than equity funds. However, the returns are comparatively lower.
Now, if you sell off your units in a debt mutual fund within 3 years, it will attract Short-Term Capital Gains Tax (STCG). Here, the tax is applicable as per the income tax slab rate.
Similarly, if you decide to sell your debt mutual fund investments after 36 months, you are liable to pay Long-Term Capital Gains Tax (LTCG). In that case, it is levied at a 20% rate following indexation along with applicable surcharge and cess.
Capital Gains Tax on Hybrid Funds
Capital gains tax on mutual fund investment is also applicable to hybrid funds. Hybrid funds, as their name suggests, are a combination of equity and debt funds. These get classified depending on their proportion of investments in equity or debt market instruments. An equity-oriented hybrid mutual fund will have more than 65% investment in equities and the rest in debts. Similarly, the investment amount is above 65% in debts for debt-oriented hybrid funds.
The mutual fund tax applicable to them also depends on whether they are equity or debt hybrid funds.
Irrespective of their classification, debt-hybrid funds will follow the capital gains taxation system applicable for debt funds. Moreover, equity-hybrid funds will follow the same as traditional equity funds.
Capital Gains Tax (CGT) is applicable both in the case of lump-sum investment and Systematic Investment Plans (SIPs).
Capital Gains Tax on SIP
SIP or Systematic Investment Plans denote a process of investing in a mutual fund via instalments. It allows you to invest in small amounts at your convenience periodically. Here, individuals can invest annually, quarterly, monthly, or even weekly.
With every SIP instalment, you buy a specific amount of mutual fund units. The amount, however, depends on the plan you invest in.
On the other hand, when you cash in on your SIP, tax is calculated on a first-in and first-out basis.
Take a look at the example below to understand better –
You invest in a mutual fund through SIP for 1 year and decide to redeem it after 14 months.
Here, the units first bought via this SIP are held for more than a year and eligible for LTCG (long-term capital gains tax). Therefore, if the return here does not exceed Rs. 1 lakh, it will not attract any taxation.
On the other hand, units bought via SIP from the third month will not complete their one year in this time period. Hence, they will be under STCG (short-term capital gains tax). Here you need to pay a flat 15% on the capital gains along with the applicable surcharge and cess.
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Securities Transaction Tax on Mutual Funds
Besides the capital gains tax and tax on dividends, mutual fund investments also attract the securities transaction tax (STT). The Government levies a 0.001% STT on the purchase or sale of equity mutual funds. It is also applicable to equity-oriented hybrid funds but not to any debt fund units.
Difference between Growth Option and Dividend Option in Mutual Funds
There is one significant difference between mutual funds that provide a Growth option and a Dividend option based on payouts. For growth funds, your returns are reinvested back into the mutual fund without any payouts in between. This increases the net asset value (NAV) of your investment, which in turn could provide better returns in the long term.
For dividends, you can either choose dividend payouts or reinvest your dividends back into the fund. If you choose to receive dividend payouts, the net asset value could of your investment decrease exponentially. In case you want to reinvest your dividends, mutual fund buys additional units as per the dividends declared.
Tax Benefits of Mutual Funds
Investing in certain mutual funds could help you save on your tax outgo. Let’s look at some of the tax benefits you can enjoy by investing in mutual funds:
1. ELSS Funds and Tax Deductions Under Section 80C
ELSS or Equity-Linked Saving Schemes are probably one of the most popular tax saving investment options under section 80C in India. You can claim a maximum deduction of Rs.1.5 lakh per year under section 80C with ELSS funds.
2. Tax Exemption with Mutual Funds
This usually works for long-term holding (holding of more than 12 months) of the equity-oriented funds. Gains made after 12 months are taxable at 10.4%. These are basically defined as Long-term Capital Gains or LTCG. However, note that tax exemption is applicable only on gains and not on the principal amount invested.
Final Word
Tax on mutual funds is an important aspect to consider before investing as it can affect the net returns. Besides taxation, the expense ratio is another factor that can lower the final return, and you should consider it before investing. In this regard, Navi Nifty 50 Index Fund can be a great investment option as it comes with an expense ratio of 0.06%, allowing you to maximize returns without hassle.
Visit Navi Mutual Fund and start your investment journey today!
FAQs
Ans: Index funds are a type of mutual fund that tracks and replicates the performance of the benchmark indices it follows.
Ans: The classification of hybrid funds includes conservative, aggressive, balanced, dynamic asset allocation, arbitrage, equity, and multi-asset funds.
Ans: A cess can be defined as a type of tax that is levied on top of the existing tax liability of an individual. Cess is usually imposed by the central or state governments to fundraise for specific purposes. On the other hand, a surcharge is a tax that is charged on the tax paid.
The primary difference between cess and surcharge is that surcharge can be deposited with the Consolidated Fund of India (CFI), while only a portion of cess can be allocated to the CFI. The surcharge can also be utilised to meet any funding requirement, while the cess can only be used for specific purposes like education.
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
