Last updated: August 28th, 2024 5:57 PM

Income Tax on Mutual Funds

The primary objective of mutual funds is to facilitate easy access to bonds and stocks for the common man with the added incentive of buying and selling the shareholding on the required day. The prospect of high capital gains and dividends require a person to invest in mutual funds to insure the funds from the decline in the purchasing power of currency. However, the capital gains which arise on these gains are taxable in Income Tax law. Owing to the fact that the capital gains are taxable, the amount which has to be paid as a tax depends on the duration for which the assessee stays invested in the funds. The duration of holding the units of the mutual fund is termed as the holding period. Based on the holding period, mutual funds can be classified as equity mutual funds, balanced mutual funds, and debt mutual funds. In this article, we discuss the applicability of income tax on mutual funds.

Taxation on Equity Funds

• Equity mutual funds are divided into two types, tax saving and non-tax saving. The tax saving equity funds can be termed as the most efficient of the instruments which come under the Income Tax Act. This can otherwise be termed as an equity-linked saving scheme (ELSS).
• Taxpayers should note that ELSS have a lock-in period of three years. The lock-in period implies that effectively once invested the taxpayer cannot redeem the units invested before three years. The key benefits are that a tax deduction of up to Rs.1.5 lakh can be claimed and taxes up to Rs.45000 can be saved by investing in ELSS under Section 80C.
• The non-tax saving equity funds are those where a tax deduction is possible only up to Rs. 1 lakh, and long-term capital gains (LTCG) more than this limit is taxed at 10% without indexation benefits. Here, indexation is the process of factoring in the inflation rate between the years, wherein funds are bought and sold and capital gain is the difference between the sale value and purchase value.
• Capital gains can be adjusted against the losses of another mutual fund within the same year. Short term capital losses can be adjusted against both long term and short term capital gains while long term capital losses shall only be adjusted against long term capital gains.
• TDS is not deducted for residents, except for NRIs. For NRIs, TDS is deducted at the rate of 15% for short term gains and 10% for long term gains in equity funds, whereas in case of non-equity funds, a rate of 30% for short term gains and 20% for long term gains is deducted.

Taxation on Debt Funds

A tax rate of 20% is charged on the debt funds of long-term capital gains after indexation. Through indexation, the purchase price of these mutual funds shall be inflated in a way that the quantum of capital gains comes down. According to the income tax slab, taxes will be effected on the short-term gains which are added to one’s income or gained through debt funds. In this case, a holding period of 36 months or more is termed as long-term, while anything less is termed as short term.

Taxation On Balanced Funds

These funds are mutual and are equity-oriented. With respect to these funds, a holding period of twelve months or more is termed as long-term, while anything less than that is termed as short term.

Taxation On SIPs

• SIP is the abbreviation for Systematic Investment Plan and represents a method wherein a fixed amount is invested in a mutual fund in a periodic manner. The period here could be fortnightly, monthly, quarterly or yearly. Each individual SIP shall be treated as a fresh investment and gains on it are taxed separately.
• Mutual funds also deduct Securities Transaction Tax (STT) on equity funds and hybrid funds, wherein a deduction is performed at the rate of 0.001%. The payments of STT need not be done separately but the deduction will be performed in the returns in a similar manner to Dividend Distribution Tax.
• Thus, it may be inferred that the longer you hold on to your mutual funds, the more tax-efficient it becomes. This is because long-term gains are not taxed as much as short-term gains.