Explained: How Mutual Funds Are Taxed
by Arnab Dey Insurance Published on: 11 July 2022 Last Updated on: 06 August 2022
Taxes are unavoidable. Thus it is wise to know how your investments will be taxed. Be it for an investment veteran or a first-time investor. Since taxes play a significant role in the overall returns from an investment. All types of Mutual funds profits and gains are taxable, much like the majority of other asset classes.
The fundamentals of mutual fund taxation are far simpler to understand when they are broken down into smaller pieces. So, let’s understand the three elements that impact the tax liabilities of mutual funds. So In the mutual fund’s definition, there is no single word about tax relaxation.
- Type Of Fund – Equity and Debt
- Nature Of Gains, Capital Gains Or Dividend – Capital gains are the returns that investors realize upon liquidating their holdings. Whereas a dividend is a portion of accumulated profits distributed to investors of a mutual fund scheme
- Investment Holding Period – The holding time determines the tax rate applicable to the capital gains. The longer your holding period, the lower your tax liability.
Income Tax On Dividends
Every type of dividend income is taxable in the investor’s hands according to their income tax bracket for “other sources of income.”
Mutual funds deduct TDS before distributing the dividends. Currently, when a mutual fund delivers dividends to its clients, the AMC must deduct 10% TDS under section 194K if the total dividends paid to an investor in a fiscal year exceed INR 5,000. While filing taxes, you can deduct the 10% TDS already deducted by the AMC and pay only the remaining balance.
Investment Holding Period And Capital Gains
The tax on capital gains from best mutual funds depends on the sort of mutual fund scheme you have invested in and how long you have held the scheme’s units.
First, let’s define long-term capital gains (LTCG) and short-term capital gains (STCG). STCG is the capital gain realized on assets kept for a substantially shorter length than LTCG.
For tax reasons, the long-term and short-term investment holding period decides the taxation for equity and debt schemes. For a capital gain on mutual funds to be considered long-term, for example, the holding time must be at least one year for equity-oriented schemes and three years for debt-oriented schemes.
Once you know the holding period, the tax on capital gains will depend on the type of mutual fund scheme in which you have invested. Mutual funds typically fall into two categories: equity and debt. However, it is also essential to discuss hybrid funds in order to comprehend how they are taxed.
Taxation On Capital Gains
1. Equity Mutual Funds
For tax reasons, equity-oriented schemes are mutual fund schemes that invest at least 65% of their assets in equities or equity-related securities.
- Short-Term Capital Gains For Equity Mutual Funds: When equity mutual fund units are liquidated within a year, fund returns are categorized under short-term capital gains. The short-term gains are subject to a 15% tax plus a 4% cess.
- Long-Term Capital Gains For Equity Mutual Funds: When equity mutual fund units are liquidated after one year, fund returns are categorized under long-term capital gains. LTCG up to INR 1 lakh is exempt from tax. However, gains over INR 1 lakh are subject to LTCG tax of 10% plus 4% cess with no indexation benefit.
Related Resource: 7 Nifty Ways The 1% Use To Reduce Tax And Protect Their Assets
2. Debt Mutual Funds
Debt mutual funds are funds that invest at least 65% of the assets in debt securities. The taxation of debt-oriented investments is simplified, and they offer superior tax efficiency compared to conventional assets such as fixed deposits.
- Short-Term Capital Gains for Debt Mutual Funds: Fund returns come under the STCG when debt mutual fund units are liquidated within three years. The short-term gains are added to the investor’s taxable gain and taxed as per the applicable tax slab rate.
- Long-Term Capital Gains for Debt Mutual Funds: Fund returns are classified under the long-term capital gains (LTCG) when debt mutual fund units are liquidated after three years. LTCG is taxable at 20% with indexation benefit.
3. Hybrid Mutual Funds
The taxes through the hybrid funds depend on whether the fund is equity- or any kind of debt-focused. A hybrid fund with an equity exposure of greater than 65% is equity-focused, whereas all other types of hybrid funds are debt-focused. Depending on their equity exposure, same of the tax laws that apply to equity or debt funds also apply to hybrid funds.
In addition to capital gains and dividend tax, you must consider the Securities Transaction Tax (STT). If you opt to sell your equity fund units, it attracts 0.001% STT. On the other hand, debt mutual funds do not have securities transaction tax.
Wrapping It Up:
Every type of mutual fund is different. And their tax amount is also additional. But the tax is not relaxed. Maybe some of the mutual funds and the circumstances are qualifying the less amount of tax, but tax relaxations are not available.
So, what types of mutual funds do you prefer for your use? You also can share your opinion through the comment sections.
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