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Mutual Fund Taxation – How are Mutual Funds Taxed?

Last Update Date : April 27, 2019
Estimated Read Time: 6 min

India being a “savings” dominated country has a population which is mostly risk-averse. Possibilities of becoming richer overnight or losing that much investment or even more goes hand in hand with risk and return. As investment in avenues which offer high return is almost like a gamble and requires considerable research, vision and deeper knowledge, mutual funds can be a better option with a minimum amount of investment pooling into diversified portfolio of funds and resulted in achieving maximum benefits. But as there is no rose without thorns, investing in mutual funds gives rise to capital gains which can be taxed. Let’s learn in detail about tax on mutual funds.

taxation of mutual funds

Mutual Funds

  • A mutual fund is an investment vehicle made up of a pool of money collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and other assets.
  • A mutual fund’s portfolio is structured and managed to achieve its investment objectives and the result of same generate interest / dividend /capital gains that are taxed by Income tax authorities.
  • The amount of tax depends on the holding period of mutual funds. Holding Period merely means the time period for which you stay invested in mutual funds. The holding period of mutual funds can be short – term or long – time, to understand the holding you must first know the types of mutual funds.

Holding Period of Mutual Funds

Now, let’s understand the holding period of Mutual Funds with the help of the table below:

BasisShort-TermLong –Term
Equity Fund< 12 months12 or more months
Debt Fund< 12 months12 or more months
Balanced Fund<36 months36 or more months

Taxation of Mutual Funds

As discussed above the amount of tax depends on the holding period and type of mutual funds. Let’s understand one by one.

Tax –Saving Equity Funds

Tax saving mutual funds are like normal mutual fund where risk is diversified across different capital market resulting in a reduction of tax burden up to limit of Rs 1,50,000. It is an investment made in equity or equity-related securities. It has lock-in period of 3 years as it is close-ended fund, Equity –Linked Savings Schemes (ELSS) is the most popular and most tax efficient saving instrument under Section 80C of the Income Tax Act 1961 where you can claim a tax deduction up to Rs 1,50,000 and save your taxes up to Rs 45,000 by investing in ELSS.

Non-Tax Savings Scheme

The long-term capital gains (LTCG) on Non-Tax saving equity funds up to Rs 1,00,000 are tax-free in your hands but in excess of Rs 1, 00,000 is now taxed at the rate of 10% without the benefit of indexation with effect from 1st April 2018. Short-Term gains from equity funds are still taxable @15% in case the same is redeemed before 12 months as there is no change in the proposed union budget 2018. This means that the LTCG tax regime would be unchanged for unlisted equity shares where Securities Transaction Tax is not paid on purchase or sale.

Securities Transaction Tax or STT is simply levied on every purchase or sale of securities that are listed on the Indian stock exchanges. This includes shares, derivatives or equity-oriented mutual funds units. An STT of 0.001% is levied by the fund company itself when you sell units of an equity fund or balanced fund. There is no STT on sale of debt funds.

Systematic Investment Plan or SIP

Systematic Investment Plan or SIPs is a periodic investment of a fixed amount regularly in different mutual fund schemes. You can start investing as small as Rs 500 and invest without having a stretch on your budget. The regularity, flexibility and compounding feature of SIP makes it most widely invested plan.  But for the purpose of taxation, each individual SIP is treated as a fresh investment and gains on it are taxed separately.

Let’s say, Greenio begins investing in an SIP of Rs 25,000 per month in an equity fund for 12 months. Here, each individual SIP is considered to be a fresh investment. Thereby, after 12 months, if Greenio decides to redeem his entire accumulated gains, all his gains will not be tax-free.
Only the gains earned on the first SIP would be tax-free because only that investment would have completed one year. The rest of the gains would be subject to short-term capital gains tax.

Debt Funds

Debt Funds is basically, investing in short-term or long-term bonds, floating rate debt or money market instruments. The dividend received in the hands of a unit holder for an equity mutual fund is completely tax-free. The dividend is also tax-free to the mutual fund house.

  • Dividends on Debt Funds: The dividend income received by a debt fund unit holder is also tax-free. But, the mutual fund company has to pay a dividend distribution tax (DDT) before distributing this dividend income to its Unit-holders. DDT on Debt Mutual Funds is 28.84%.

Balanced Funds

Balanced funds are a combination of both equity and debt, at least 65% of their assets are in equities that’s why their tax treatment is exactly the same as non–tax savings equity funds.

Situation in India

The mutual fund industry is one of the fastest growing sectors in the Indian Capital and Financial markets. In the last few years, household’s income levels have grown significantly, leading to a commensurate increase in household’s savings. The considerable rise in household’s financial savings point towards the huge market potential of the Mutual fund industry in India.

The tax benefits allowed on mutual fund schemes (for example investment made in Equity Linked Saving Scheme (ELSS) is qualified for tax deductions under section 80C of the Income Tax Act) also have helped mutual funds to evolve as the preferred form of investment among the salaried income earners.

Besides, the Indian Mutual fund industry that started with traditional products like equity fund, debt fund and the balanced fund has significantly expanded its product portfolio. Today, the industry has introduced an array of products such as liquid/money market funds, sector-specific funds, index funds, gilt funds, capital protection oriented schemes, special category funds, insurance-linked funds, exchange-traded funds, etc. It also has introduced Gold ETF fund in 2007 with an aim to allow mutual funds to invest in gold or gold related instruments. Further, the industry has launched special schemes to invest in foreign securities. The wide variety of schemes offered by the Indian Mutual fund industry provides multiple options of investment to the common man.

Frequently Asked Questions

Investing in mutual funds is the same as investing in stock market / mutual fund is an equity product?

Mutual funds invest in stock market (i.e., equities), bond market (corporate bonds as well as govt. bonds) and Money Market instruments such as Treasury Bills, Commercial Papers, Certificate of Deposit, Collateral Borrowing & Lending Obligation (CBLO) etc. Many of these instruments are not available to retail investors due to large ticket size of minimum order quantity (such as G-Secs) and hence, retail investors could participate in such investments through mutual fund schemes too.

What is tax on long-term capital gains on sale of equity shares/units of equity oriented fund if more than Rs 1 lakh is earned?

It will be taxed @ 10 % without indexation as per Finance Bill Budget 2018.

Is there any kind of relief for the existing investors for the amount of capital gains?

Yes, relief to existing investors to exempt amount of capital gains up to 31 Jan 2018. The amount of gains made thereafter this cut-off date will be taxed as per Finance budget 2018.

Summaiya being an NRI, what will be the tax rates applicable to her?

The tax rates applicable to her will be as below;

Mutual Fund Redemption By NRIs & TDs Rates
Equity Oriented15%Nil
Debt Mutual Funds30%On Listed Fund – 20%

(with Indexation)

Unlisted Funds – 30%

(without Indexation )

The more you hold, the less you pay i.e. if you hold your mutual funds units for longer period, the more tax-efficient they become as tax on short –term gains are more than tax on long-term gains. Looking forward for tax planning or worried about your returns? H&R Block can always be your helping hand.

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CA Shreya Oturkar
Shreya is a tax advisor at H&R Block (India) with intensive experience in SME taxation and audit. She holds an advanced post graduate qualification in accounting and is highly skilled in financial analysis and reporting. Apart from her professional achievements, Shreya is a talented artist with a flair for free-hand sketching!

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