Under the equity/debt mutual funds, you invest a fixed sum of money in a scheme either every month or quarter. When you’re investing in a particular mutual fund, the first thing you need to do to assess its returns is to know how it will be taxed. It is the post tax returns that will matter.

Firstly, you’ve to consider capital gain taxation on mutual funds. Capital gain is the value of appreciation in your asset. If you buy something for Rs 4 Lakh & sell it for Rs 4.5 Lakh, you have made a Capital Gain of Rs 50000. Capital Gains are further divided into short term & long term depending on the period of holding of assets.

Short term capital Gain arises if investment is held for less than 1 year or in simple words sold before completion of 1 year. Long Term Capital Gain arises if investment is sold after 1 year.

Mutual Fund Capital Gain Tax further depends on the type of fund- whether it is equity or debt.

Equity oriented Mutual Funds are defined under Chapter XII-E of Income Tax Act(“ITA”), as those mutual funds where equity holding is more than 65% of the total portfolio  and Which has been setup under a scheme of mutual fund specified under section 10 (23D) of ITA.

Mutual funds which invest in other funds & international funds (funds which have more than 35% exposure to international equities) will be kept under debt category for tax purpose.

We will examine the tax issues in the hands of investors investing in mutual funds in – dividends, long term capital gains and short term capital gains and whether you’re eligible for tax deduction on investment in mutual funds.

Mutual fund (MF) and Equity-linked savings scheme (ELSS): Subscription to MFs and ELSSs qualifies for deduction under Section 80C.Investment in ELSS has a lock-in period of 3 years. Pre-mature withdrawals is not allowed under any circumstance

Section 10(35) (a) of ITA states that any income received in respect of the units of mutual funds specified u/s 10(23D) of ITA is exempt from tax. As a result of this provision, the dividend received from equity mutual funds is exempt from tax. By virtue of proviso to section 115 (R) (2) of ITA, equity oriented schemes are exempt from dividend distribution tax (“DDT”). However, DDT has to be paid in the case of non-equity oriented schemes.

Income distributed to Effective tax rate (%) (Money Market Mutual Fund or a Liquid Fund) Effective tax rate (%)
(others)i.e., Debt Fund, Fund of Funds etc.
Individuals and Hindu Undivided Families (‘HUFs’) 28.325[1]
(tax rate of 25% plus surcharges @ 10% thereon plus additional surcharge by way of education cess @ 3% on the income tax plus surcharge)- reference to Section 115 R of Income Tax.
14.1625% (tax rate of 12.5% plus surcharges @ 5% thereon plus additional surcharge by way of education cess @ 3% on the income tax plus surcharge)
Persons other than individuals and HUFs 28.325
(tax rate of 25% plus surcharges @ 10% thereon plus additional surcharge by way of education cess @ 3% on the income tax plus Surcharge)
22.66% (tax rate of 20% plus surcharges @ 10% thereon plus additional surcharge by way of education cess @ 3% on the income tax plus surcharge)

 [1] Have to check the tax rates

TAXATION OF LONG TERM AND SHORT TERM CAPITAL GAINS FROM MF UNITS

Long Term Capital gain on Equity Mutual Funds – if you buy & hold an equity Mutual Fund for more than 1 year, there will be NIL Tax. E.g. If you invest Rs 1 lakh in XYZ Fund & after 1 year, its value is Rs 1.3 Lakh – there will be zero tax on capital appreciation of Rs 30000. This is a very big advantage of equity mutual funds.

Short Term Capital gain on Equity Mutual Funds – if you sell equity mutual fund before completion of 1 year you need to pay tax of 15% on capital gains. In the above example where gain was Rs 30000 – if this was a short term capital gain, investor would have paid Rs 4500 as short term Capital Gain.

Note for NRIs – Same capital gain is applied for NRIs but in case of Short Term Capital Gain there will be a TDS (tax deducted at source). Which means Tax will be deducted by Mutual Fund Company before paying redemption (sell) amount.

In case of individual/ HUFs being residents , where the Total Income, excluding Short Term Capital Gains, is below the maximum amount not chargeable to tax, then the difference between the current maximum amount not chargeable to tax, and total income excluding Short Term Capital Gains, shall be adjusted from capital gains. Therefore, only balance STCG will be liable to income tax at the rate of 15%.

In respect of short term capital gains arising to non resident individual unit holders, the Mutual Fund is required to deduct tax at source @15% +SC+EC, in case of Equity Funds and @ 30.9% (30% +SC+EC) in case of non equity schemes.

Capital Gain Tax on Debt Mutual Funds

In case of Short Term Capital gain on Debt Mutual Funds, any short term capital gain that arises due to selling of debt fund before 1 year will be added to investor’s income. Once it is added to income it will be taxed according to tax slab of that individual.

Long Term Capital gain on Debt Mutual Funds – here taxation depends on whether investor would like to use indexation or not.

Indexation – 10% tax on capital gains

With Indexation – 20% tax on capital gains

Note for NRIs – NRIs will receive their redemption amount only after paying TDS on capital gains:

Short Term – 30% TDS

Long Term – 20% TDS

Cess of 3% will also be applied to this TDS.

A simplified table for short term cap gains in case of equity mutual funds

Mutual(Mr. Vikram Ramchand, Founder at MakeMyReturns.com )

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One response to “Tax benefits of investing in mutual funds”

  1. Prof. Bajaj says:

    1. Switch from Dividend to Growth option is treated as a sale of existing scheme and purchase in new scheme. So STCG will be taxed.

    2. Switch from Regular to Direct plan is also treated as a sale of existing scheme and purchase in new scheme. STCG will be taxed.

  2. C.S.Nanaiah says:

    All tax matters concentrated on LTCG, STCG and DDT. I have not got from any where the clarifications authenticatively on the following:
    (1) Whether switching from dividend option to growth option within a period of three years in case of debit funds and within one year in case of equity funds is treated as redemption and reinvestment and taxed as applicable to Short term capital gain or not
    (2) Similarly, in case of conversion to Direct Plan within the period as mentioned above, is treated as redemption and reinvestment and taxed as applicable to sort term capital gain?

  3. Kirti says:

    Thanks

    Dear Mr. Bharat Jadhav for your valuable feedback

    it helped me in classifying equity and debt oriented mutual funds

  4. Bharat Jadhav says:

    Simply Type your Fund name in google and Click money control link, money control site show detail scheme related documents, in left hand side overview section click it you found asset allocation details on this asset allocation you get information about it is equity oriented or debt oriented..

  5. pawan agrawal says:

    Dear Archana, you may mail your fund details to pawan@investguru.in or leave a whatsapp msg on +919811301416 and we shall solve your query.

  6. archana says:

    Dear sir,

    Myself NRI working aboard. Having mutual funds from HDFC and SBI. But nowhere i could find out on statement whether it is Equity or Debt. how to find out. please reply.
    Regards, Archana

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