One of the best ways to invest your money is investing in mutual funds. However, many of us do not know its tax implications. If we can plan well, we can save tax on mutual fund returns. In this article, I would explain you as to how mutual fund returns are taxed and possible ways to save tax on such returns.

1. Some quick definitions Definitions Related to Mutual Fund

1) Growth option and Dividend option in mutual funds

Before I move into the actual taxation part, you might be aware that mutual funds come with two options, growth option and Dividend option. Growth mutual funds are those where the returns would automatically get reinvested and you would get such returns or gains when you sell your mutual fund units. Dividend option in mutual funds on the other hand is where the returns are paid to mutual fund unit holders in the form of dividend at regular intervals. This comes like regular income.

2) Equity mutual funds and Debt mutual funds:

For taxation purposes, mutual funds are categorized into two buckets i.e. Equity mutual funds and debt mutual funds. Equity mutual funds are those which invests 65% in equity related instruments and remaining 35% in debt related securities. It includes, index funds, large cap mutual funds, mid-cap/small cap mutual funds, diversified mutual funds, global mutual funds and balanced mutual funds.

Debt mutual funds on the other hand, are those which invests majorly in debt related instruments. It includes ultra short term debt funds, debt mutual funds, liquid funds, fund of funds etc.

2. How mutual fund returns are taxed?

We would categorize the mutual fund returns/gains taxation into 3 parts.

1) Dividend option:

Any dividend received from mutual funds are tax free. Means if you are investing in mutual funds with dividend option the returns from such dividend income is not taxable.

2) Equity funds with Growth option

– Redemption < 1 year – Short term capital gain: If you have invested in equity funds with growth option and sold / redeemed before one year period, you are liable to pay short term capital gains tax. Currently short term capital gain are 15% on the returns (4% cess additionally to be payable which would come to 15.60%). E.g. Mahesh purchased HDFC Top 200 equity Fund and chosen growth option in Jul-2010 for Rs 1,00,000 and sold in Jun-2011 for Rs 1,10,000. Since the time frame is < 365 days, the returns of Rs 10,000 are taxed @ 15.60% = Rs 1,560

Redemption > 1 year – Long term capital gains: If you sell or redeem your mutual funds after a 1 year period, it would fall under the long term capital gain and the returns are tax free.

However as per the newly inserted section 112A via Finance Act 2018, if the amount of long- term Capital gain exceeds Rs 1,00,000 than the amount in excess of Rs 1,00,000 shall be chargeable to tax @ 10% without indexation  (plus  heath and education cess and surcharge). However the application of sec 112A is subjected to certain conditions, one of it being the transfer should have taken place on or after 1stApril ,2018.

All gains until January 31, 2018 have been “grandfathered”. So you can assume the new cost of holding your Equity Mutual Funds is the closing price on January 31, 2018. The start date of your holding remains the original purchase date.

E.g. Mahesh  purchased HDFC Top 200 mutual funds in Jul-2010 for Rs 1,00,000 and sold in Aug-2011 for Rs 1,10,000 and made a profit of Rs 10,000. Since the time frame is > 1 year, which is a long term capital gain, the returns are tax free.However in case the profit is more than Rs 1 lac it will be taxed at 10% without indexation(plus  heath and education cess and surcharge) Wef  01.04.2018

3) Debt mutual funds with growth option

– Redemption within 36 months – Short term capital gains: If you are selling or redeeming your debt mutual fund before 36 months, it is short term in nature and the profits are fully taxable. Means you need to add such profits / gains to your taxable income and pay income tax based on your income tax slab. E.g. Mahesh purchased SBI Dynamic Bond fund, which is a debt mutual fund with growth option in Jul-2017 for Rs 1,00,000 and sold in Jun-2018 for Rs 1,10,000. Since the time frame is <36 months, the returns / gains of Rs 10,000 are added to an income tax slab of Sreenivas and necessary income tax has to be paid.

Redemption > 36 months – Long term capital gains: If you sell your debt mutual funds after 36 months, it is termed as long term capital gain. In such case, the tax would be paid at the rate 20%  after indexation benefit

E.g. Indian government provides the Inflation indexation data every year. For year 2018-19: 280 and 272 for 2017-18 E.g. Mahesh purchased SBI Dynbamic Bond debt mutual fund with growth option on Jul-2017 for Rs 1,00,000 and sold in Sep-2018 for Rs 120,000.

ii) Computation based on 20% tax after indexation benefit:

  • Indexed value is 100,000 x 280/272 = Rs 102,941.
  • Taxable Amt would be Rs 120,000 – Rs 102,941 = Rs 17,059
  • 20% tax on taxable amount is Rs 10,014 x 20% = Rs 3,411

3. How to save income tax on mutual fund returns?

There are several ways where you can plan and save income tax on returns or gains from mutual funds.

1) Invest in Equity mutual funds if you are risk taker:

Though equity mutual funds are risky, invest in top rated equity mutual funds for the long term. One side you would get capital appreciation and other side you would get tax free benefit upto a profit of Rs 1 lacs.

2) Invest in debt funds if you have a low risk appetite:

If you are a low risk taker, invest in debt mutual funds and take the advantage of indexation. Avoid investing for < 36 months  in debt mutual funds with growth option.

3) Invest in dividend options for regular income:

If you are a senior citizen or looking for regular income, opting for dividend option in mutual fund would help you to get a regular income. However, you should note that such income is not fixed. You may even get lower returns than bank fixed deposit rates in some cases.

Understanding how mutual fund returns are taxed would help you to plan well and reduce your taxes on mutual fund returns or gains.

Suresh KP, founder of Myinvestmentideas.com has posted this guest article. He can be reached at suresh@myinvestmentideas.com for any clarifications

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19 responses to “How to save tax on mutual fund returns / Income?”

  1. Archana R says:

    In HDFC Midcap opportunity growth fund if i am investing i made redemption after one year. It is an monthly payment fund. How the tax is applicable? From when we have to consider the purchase. Is it when the first payment started or after last installment?

    • Ranjana says:

      each SIP is considered for calculating whether it is long term or short term. As you said you have made investment one yearbefore so it is a short term capital gain. if it is Equity oriented mutual fund, condition for long term capital gain is 12months or more. it is all depends on the type and scheme of mutual fund.

    • Ranjana says:

      each SIP is considered for calculating whether it is long term or short term. As you said you have made investment one yearbefore so it is a short term capital gain. if it is Equity oriented mutual fund, condition for long term capital gain is 12months or more. it is all depends on the type and scheme of mutual fund.

  2. BK says:

    Excellent information !!
    One question – By which month of the fiscal year is the inflation indexation value published by the Govt/RBI?

  3. mahesh says:

    Could I get any deduction u/s60c by investing in this maturity growth slp plan?

  4. ANIL sharma says:

    Nice

  5. S K GHOSH says:

    If I GAIN SOME AMOUNT OF MONEY BY WAY OF LONG TERM EQUITY MF, SHOULD I HAVE TO FILE ITR-2 RETURN? PRESENTLY I FILE ITR-1 RETURN. I AM IN 30% INCOME SLAB

  6. Kalyan Kashyap says:

    Very helpful for me to understand about mutual funds easily. Thanks for such a clear cut explanations with examples.

    But could some one say me whether any changes took place in the tax rates mention above?

    Best Regards,
    Kalyan Kashyap.

  7. Ananya says:

    Extremely well written. Would like to read more of your writings.

  8. Devashees Das says:

    Good article for the beginners. It is simple, pointed and give good direction for investment

  9. Kailash says:

    I switched from debt mutual fund to equity mutual fund without redeeming the investment made in 2014-15 in less than one year. Am I liable to pay income tax on the shortterm gains by this switch of mutual funds in the year 2014-15 , even if I have not cashed these gains in the year 2014-15.

  10. ISHWAR says:

    dear sir
    it is good to read before investing in mutual fund
    thanks for good suggestion
    ishwar

  11. yeshvant wadekar says:

    THIS ARTICLE NEEDS TO BE CHANGED ON THE BACKGROUND OF BUDGET 2014.
    THEN IT WILL BE VERY USEFUL.

  12. manish says:

    Sir,

    need information of tax on SIP (HDFC Growth fund

  13. NAGARAJU says:

    Sir,

    It is very clear about tax on returns, I hope you should provide 80C or Chapter VI deductions available on investing in mutual funds.

    Thanks and regards,
    Nagaraju
    CA final

  14. kuppuswamy says:

    dear suresh
    i congratulate you for writing this article.
    It’s lucid,near complete and achieves its goal.
    Be writing such good articles.
    swamypk

    • Biswa says:

      First of all thanks a ton Suresh for writing such an excellent article. Very useful for beginners like me to understand the tax implication in case of Mutual Funds investments. Kudos!!!!

      One thing that I have observed looks like the calculation for the Double Indexation scenario is incorrect.

      1. Considering it is sold for 130000 as mentioned in the article, the calculation should have been as follows-

      Without indexation: Rs 30,000 x 10% = Rs 3000
      With indexation: Indexed value Rs 100,000 x 852 /711 = 119,831
      Taxable amount Rs 130,000 – 119,831 = Rs 10691

      20% tax = Rs 10169 x 20% = Rs 2192
      Lowest of Rs 2192 or Rs 3000 = Rs 2192 is the tax payable

      2. However,if it is sold for 120000 the calculation should have been as follows-

      Without indexation: Rs 20000 x 10% = Rs 2000
      With indexation: Indexed value Rs 100,000 x 852 /711 = 119,831
      Taxable amount Rs 120000 – 119,831 = Rs 169

      20% tax = Rs 169 x 20% = Rs 34
      Lowest of Rs 2000 or Rs 34 = Rs 34 is the tax payable

      Apologies if I missed something.

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