Tax on mutual funds is paid against the profits earned through investment in equity and debt schemes. In case of equity funds, tax is levied on the capital gains whereas, the same is calculated on dividends earned, in 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.
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 case of lumpsum 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 installments. 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 installment, 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.
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.
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 navimutualfunds.com and start your investment journey today!
Frequently Asked Questions
What is an index fund?
Index funds are a type of mutual fund that tracks and replicates the performance of the benchmark indices it follows.
What is the classification of hybrid funds?
The classification of hybrid funds includes conservative, aggressive, balanced, dynamic asset allocation, arbitrage, equity, and multi-asset funds.
What are cess and surcharge?
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. Surcharge can also be utilised to meet any funding requirement, while cess can only be used for specific purposes like education.
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