Mutual funds ensure that every type of investor can select a scheme that best matches their needs by offering a wide variety of fund options. However, while consumers focus on criteria such as return potential, past performance, and expense ratio, they frequently disregard tax consequences.
Mutual fund taxes is a vital factor that cannot be ignored while making the best investing selection. Examine the taxation of several forms of mutual funds in India.
Variations of Mutual Funds
There are various sorts of mutual funds, but they can be divided into three categories based on their allocation. These include:
- Capital Funds
- Debt Funds
- Hybrid Funds
Taxation on equity mutual fund investments
An investor can earn returns from equities mutual funds in two distinct ways: capital gains and dividends. When investing in an equity mutual fund, you have the choice between the growth (non-dividend) and dividend options. Taxation differs for both of these alternatives:
Tax on Capital Gains
• LTCG (Long-Term Capital Gains) taxes is applied to investments held for over a year in equity funds. Short-Term Capital Gains (STCG) are applicable if an investment is held for less than a year.
If annual gains exceed Rs. 1 lakh, equity funds are subject to a 10 percent long-term capital gains tax, plus applicable cess and surcharge. No indexation benefit is offered for equity funds. Indexation assists in adjusting the acquisition price of mutual funds to account for inflation. STCG gains are subject to a 15% tax, plus any relevant cess and surcharge (also check: mutual fund distributor platform).
Tax on Dividends
Before February 2020, the fund house was responsible for paying the 10% DDT (Dividend Distribution Tax) and surcharge on behalf of the investor to the government. However, Budget 2020 has eliminated DDT. Beginning in April 2020, the fund house will no longer deduct DDT.
The dividend will be paid in full to the investor after applicable TDS is deducted, and the investor must pay tax on the dividends according to his or her income tax bracket. Note that the tax described above applies to ELSS (Equity-Linked Savings Scheme) mutual funds as well.
Taxation of mutual fund debt
The length of long-term capital gains and short-term capital gains differs across equity and debt funds.
The long-term capital gains tax rate for debt funds is 20%, with an indexation benefit for assets held for more than 36 months.
Short-term gains are those realised on investments held for less than 36 months. Such gains are added to the investor’s taxable income and taxed according to his or her tax bracket.
Tax on Hybrid/Balanced Funds
The taxation of hybrid funds relies on the scheme’s portfolio. As stated previously, if more than 65 percent of a scheme’s portfolio assets consist of equities instruments, the scheme is designated an equity-oriented fund and is taxed according to the equity fund taxation policy.
If fewer than 65 percent of the scheme’s holdings are equity securities, it is regarded a debt fund and taxed as such. Even if a balanced fund comprises 50 percent equity investments and 50 percent debt investments, it will continue to be taxed as a debt fund.
Tax-aware investment in mutual funds
Taxation has extensive effects on investments. Therefore, it is always preferable to consider the impact of taxes on your assets in order to avoid future discrepancies and better manage your investment trip.
Now that you understand how income tax on mutual funds in India is calculated, you can make an informed investment decision and choose funds that match your investment profile and financial goals.