Are you having questions about the taxes on mutual funds? We all do when we are setting foot on brand new territory – the brand new territory being investments in mutual funds. The best way you can possibly start calculating the taxes on your mutual funds would be through knowing how they are taxed the proper way.
We can get you through that effortlessly. Also, it is good that you know this because the way your mutual funds are treated for tax purposes has so much to do with the type of investments within the fund’s portfolio.
In order to understand how mutual funds are taxed in India, you would first have to understand the returns on these mutual funds.
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Returns on Mutual Funds
Now, mutual fund investments could be of mainly two types. For instance, you invest in a newly listed IPO – and when the company grows, the capital increases, and you have earned through capital gains when you sell it for a higher price than you have bought it. On the other hand, just say you have invested in a TATA mutual fund that offers dividends – you will be making your profits through the dividend.
So, now you know that returns are of two types – that is: 1) Capital Gains, and 2) Dividends.
What are Capital Gains from Mutual Funds?
Capital gains mean the gains or the profits you would make on the sale of any capital assets. The assets could either be financial assets or non-financial assets. Non-financial assets would be any physical item ranging from property, automobiles, and more. Financial assets are the assets that are non-physical or intangible in general – they are like bonds, stocks, mutual funds, deposits, and more.
What are Dividends in Mutual Funds?
A dividend plan in a mutual fund is where the profits from investments are distributed to investors in the form of a dividend. Dividends would be paid every month, quarterly, half-yearly, or even yearly. The frequency of the dividend payments would not be guaranteed and depends on the surplus that the fund would generate.
So, now that you know these two factors let us get straight to the taxes on these two kinds of returns from mutual funds.
Taxes on Dividends of Mutual Funds
According to the amendments made in the union budget, the dividends that are offered by any mutual fund scheme are taxed in a classical manner. That is – the dividends that have been received by an investor are added to their taxable income and are taxed at their respective income tax slab rate.
Previously – dividends were tax-free in the hands of the investors as the companies had paid dividend distribution tax before sharing the profits with investors in the form of dividends. During the regime, dividends of up to 10 lakh rupees for a year were tax-free in the hands of the investor.
Any dividend in excess of 10 lakh rupees for a financial year attracted dividends distributed tax at 10%.
Taxes on Capital Gains of Mutual Funds
The tax rate of capital gains of mutual funds depends on the holding period and type of mutual fund. The holding period is the time period for which the mutual fund units are held by the investor. In simpler words – the holding period is the time period between the date of the purchase and the sale of the mutual fund unit. Here are the categories of capital gains associated with mutual fund holding period and how they are termed as short and long term capital gains:
- Equity Funds – Shorter than 12 months (short term), More than 12 months (long term)
- Debt Funds – Less than 36 months (short term) and more than 36 months (long term)
- Hybrid Equity-Oriented Funds – Less than 12 months (short term) and More than 12 months (long term)
- Hybrid Debt-Oriented Funds – Less than 36 months (short term) and more than 36 months (long term).
Tax on Equity Funds
Equity Funds are mutual funds whose portfolio’s equity exposure is more than 65%. As already said, short-term capital gains are realized on redeeming the equity fund units within a holding period of one year. The gains are taxed at a flat 15%, irrespective of the income tax bracket.
You would make a long-term capital gain when selling your equity fund units after a holding period of a year or more than that. The capital gains of up to one lakh rupees for a year are exempt from taxes. Any of the long-term capital gains that exceed this limit would attract LTCG tax at the rate of 10%, and there would be no benefit of indexation given.
Taxes on Debt Funds
Debt funds are mutual funds whose portfolio’s debt exposure is more than 65%. You will get short-term capital gains on redeeming your debt fund units within a holding tenure of three years. The gains are included in the taxable income and are taxed at your income tax slab rate.
Long-term capital gains are realized when you would sell the units of debt funds after a holding period of three years. The gains are taxed at the flat rate of 20% after the indexation. You will be levied with applicable cess and surcharge on tax.
Taxes on Hybrid Funds
The rate of taxation on capital gains, hybrid or balanced funds depends on the equity exposure of the specific portfolio. If the equity exposure is higher than 65%, the fund’s scheme is taxed like an equity fund; if not, then the rules of tax of the debt fund would apply.
It could be hard finding the taxation of your mutual funds, but it is always good to know them so you would not be led to a big surprise.