How are Mutual Funds Taxed?

We all make investments to profit from them through dividends or capital gains. There is also a tax if there is income. Mutual fund investments are taxed differently depending on the sort of fund you invested in and how long you held it.

Here are some essential tax-related facts about mutual fund returns, focusing on capital gains and dividend income taxes.

What is a Mutual Fund?

A mutual fund invests the majority of its resources in emerging firms’ stocks or equities that have the potential to increase in value. Companies that make rapid progress and can provide investors with more returns make up a portfolio of the best mutual funds in India.

These funds have a high expense ratio, a high beta, which implies high volatility, a high alpha, which indicates a high return compared to peers, and a nearly nonexistent dividend distribution.

Mutual fund taxes

Two main tax kinds apply to gains from mutual funds: capital gains tax and dividend payment tax. Let’s dissect them both.

Mutual fund capital gains tax

The amount of capital gains taxes on mutual funds determine how long you keep your investments. The categories are listed below. If you invest in equity mutual funds and generate capital gains in less than a year, the tax rate is a flat 15% regardless of your income tax bracket.

Long-term capital gains are subject to a 10% tax, with an exemption for amounts under Rs. 1 lakh. Your income band determines the STCG for debt funds; after indexation, the LTCG is taxed at 20%.

Dividend payments are taxable

Gains from mutual funds can also be realized through dividend payments, which are also subject to taxation. Companies must pay dividends to their shareholders. These are frequently financed by the company’s profits and serve as a way to decrease excess liquidity and raise the stock’s allure. According to the 2020 budget, dividend payments are taxed at the same rate as your other income.

Debt Mutual Fund Capital Gains Tax Rules

STCG Tax for Mutual Funds 

If an investment is sold within 36 months, any profits realized through Debt Mutual Funds are regarded as short-term capital gains (3 years). These gains increase your income, and your income tax bracket determines the tax you pay on mutual fund returns.

For instance, Sanjeev puts Rs 2 lakhs in a debt fund and is subject to a 30% income tax rate. He redeemed his investment for Rs. 2.5 lakhs after two years. Gains from the redemption will be considered short-term capital gains because the fund units were held for less than 36 months (3 years). Therefore, on the returns from the Debt Fund, he will be required to pay Rs. 15,000 (30% of Rs. 50,000) in capital gains tax.

LTCG Tax for Mutual Funds

If assets are held for more than 36 months, profits realized through debt mutual funds are recognized as long-term capital gains. Following the provision of indexation benefits on cost, the long-term capital gain is subject to a 20% tax.

Using indexation of LTCG Tax for Mutual Funds, you can modify a debt fund’s purchase price to consider inflation. Your purchase price is raised due to the adjustment, which lowers your taxable capital gains. If you hold onto your investment in a mutual debt fund for three years or more before redeeming, you will have to pay less tax on your withdrawal.

Assume, for instance, that in FY 2015–16, Sanjeev put Rs. 2 lakh in a debt fund and held onto it till FY 2020–21. He then redeemed his investment for Rs 2.5 lakh in FY 2020–2021. His gains from the program will be regarded as long-term gains because he has held his investment for more than three years, in which case the capital gains tax rate of 20% with indexation advantage will be applicable.

List of Best Mutual Funds in India

Sector-based investments

Mutual funds focusing on a particular sector invest in that sector, including technology, metals, energy, or infrastructure. More than 80% of the AUM in the growth sector MF’s equity portfolio is allocated to stocks of small, midsize, and large-cap enterprises.

Technology Fund by ICICI

Over 80% of the AUM of the ICICI Prudential Technology Fund is allocated to investments in the IT and telecom sectors. It is one of the newer mutual funds that have had excellent returns recently. In domestic equities, the fund has an investment of 89.01%, of which 74.35% are large-cap companies, 5.66% are mid-cap stocks, and 6.41% are small-cap stocks. The fund invests 0.35% of its assets in debt, mainly in government securities.

Infrastructure Fund Quant

The Quant Infrastructure Fund, as its name implies, makes investments in the infrastructure industry, which is made up of a wide variety of businesses involved in infrastructure-related operations.

The majority of the fund’s holdings are split between construction and engineering (21.09%), logistics (15.01%), and public banks (8%), respectively. One of the traditional mutual funds (MFs) among high-return funds. The fund has a 98.84% investment in domestic equities, of which 52.75% are large-cap companies, 16.07% are mid-cap stocks, and 27.47% are small-cap stocks.

Tax-savings accounts

The EEE (Exempt-Exempt-Exempt) regime, in which investments, returns, and withdrawals are all tax-free, applies to tax-saving mutual funds. To receive these perks, participants must lock in their contributions for three years, unlike typical mutual funds.

Mirae Asset Tax Savings Fund

One of the first fund companies, The Mirae Asset Tax Saver Fund Direct-Growth, allocates the majority of its holdings, 19.24%, to private banks, 12.54% to IT services and consulting, and 7.63% to oil and gas.

The fund has a 99.11% position in domestic equities, of which 58.49% are large-cap stocks, 11.52% are mid-cap stocks, and 7.1% are small-cap stocks.

Focused resources

Depending on a company’s market capitalization, which can range from tiny to massive, focused mutual funds will invest in that company. These funds are suitable for investors who want to use one of these products to stabilize their whole portfolio.

Axis Small Cap Fund

Small-cap mutual funds were invented under the Axis Small Cap Fund plan. It is good at reducing losses in a weak market. Most of the fund’s assets are split between IT at 8.5%, Diversified Chemicals at 10.39%, and Investment Banking & Brokerage at 20.75%. The fund invests 79.37% of its capital in domestic equities, with 58.4% of its holdings in small-cap stocks, 4.43% in mid-cap stocks, and 0.34% in large-cap stocks.

Mid-Cap Growth Fund from Quant

In mid-cap mutual funds, the Quant mid-cap fund plan has been aggressive. Most of the fund’s interests are divided between public banks, logistics, and hotels. The fund has a 98.6% investment in domestic equities, of which 30.27% are large-cap companies, 42.97% are mid-cap stocks, and 8.65% are small-cap stocks.

Tax on Mutual Fund Dividend Income

Dividends are another method of earning profits from mutual funds besides capital growth. Both equity and debt mutual fund dividends are taxable in the investor’s hands. Dividends from mutual funds are taxed according to the investor’s tax bracket.

Therefore, the dividends received by investors in the 30% tax bracket will be subject to a 30% tax. With careful preparation and your newfound knowledge of mutual fund taxation, you can reduce the taxes you must pay on your returns.

Conclusion

Mutual funds seek to provide you with a specific rate of return over a particular time frame. However, if you don’t factor in mutual fund taxes, they can end up reducing your returns and tipping your portfolio out of balance.SBNRI is an authorised Mutual Fund Distributor platform & registered with Association of Mutual Funds in India (AMFI). ARN No. 246671. Keeping these taxes in mind when investing in mutual funds will help you obtain more precise information about your returns.