While you are creating an investment portfolio, you must not overlook how mutual funds are taxed. Different taxation rates applicable to different types of investments, and such rates may specific investment options more attractive than others. For example, you may consider tax-free bonds giving a yield of 6% per annum as low-yielding investments when compared with bank fixed deposits giving 7% interest. However, when you compare the post-tax returns with tax rate assumed to be 30%, the tax-free bonds seem better investment option with 6% post-tax returns as against 4.9% post-tax returns by bank FDs. As such, it becomes vital that you to take cognisance of the tax incidence on your investment returns and make an informed decision. Staying aware of the tax laws regarding your investments will also help you ensure tax compliance. This article will discuss the tax laws governing your investments in mutual funds.
When are you required to pay taxes?
Unlike the interest income from fixed deposits, for which you may need to pay tax on the accrual basis, you are only required to pay tax on mutual funds once you redeem your investments and realise your profits from the investments in mutual funds.
However, you must note that the switch transactions are also treated as a redemption from one mutual fund scheme and an investment in another scheme. As such, you must calculate tax even in case of switch transactions.
Categorisation of mutual fund taxation
Depending upon the type of the investment portfolio maintained by the mutual fund schemes, funds may be categorised into two categories for tax laws:
Equity-oriented funds
As per the tax laws, equity-oriented funds are such funds which invest 65% or more of their net assets in listed equity securities of domestic companies.
Other funds
This is the residual category, and all other mutual fund schemes other than equity- oriented mutual fund schemes are categorised here. All the Fund of Funds (FoFs) (except FoFs further investing in pure equity ETFs) are also classified under this category only, even if they may be investing in other equity-oriented funds.
The categorisation of capital gains
As per income tax laws, capital gains may be classified into two categories depending upon the holding period of the mutual fund investments:
Short Term Capital Gains (STCG)
Short term capital gains on mutual fund refers to the returns from investments that you hold for a relatively short period. Such a period has been specified differently for different investments under tax laws. For example, in case of equity-oriented mutual fund schemes, this period is less than 12 months, while in case of other mutual fund schemes, it is less than 36 months.
Long-Term Capital Gains (LTCG)
If you have stayed invested in the mutual fund for longer than the specified period as mentioned above, the gains from such investments will be considered as long term capital gains on mutual fund.
Applicable tax rates for capital gains from mutual fund investments
As per the prevailing tax laws, the following tax rates are applicable for capital gains from mutual fund investments. Here’s how you can calculate tax on mutual fund returns:
Equity oriented funds
STCG from such funds are taxed at 15% (plus applicable cess and surcharge), while LTCG is taxed at 10% (plus applicable cess and surcharge). The investors may also avail an exemption of up to ₹1 lakh a year in respect of LTCG from equity shares and equity-oriented mutual funds, taken together. Capital gains in both the cases, whether LTCG or STCG, may be calculated as the difference between the redemption value and the amount invested. Investors are not eligible for indexation benefit in the case of LTCG from equity-oriented funds.
Gains from other mutual fund schemes
STCG from such funds are taxed at the regular tax rates, as applicable to the investor. On the other hand, LTCG from such funds is taxed at 20% (plus applicable cess and surcharge) with indexation benefit. Indexation benefit allows the investors to adjust the investment cost with the inflation index, as notified by the Govt. every year based on prevailing inflation. As such, LTCG is calculated as the difference between the redemption value and the indexed investment cost instead of the actual amount invested as in the case of STCG. Accordingly, the effective tax incidence is even lesser than the applicable tax rate of 20%.
Taxation of dividend received from mutual funds
Wondering about the taxability of dividends from mutual fund? If you have invested in the dividend plan of the mutual fund schemes, you may be receiving dividend income directly in the bank accounts apart from the appreciation in the mutual fund NAV (Net Asset Value). Such dividend income is exempt in the hands of the investor. However, the mutual funds are liable to pay Dividend Distribution Tax as per the rates specified in respect of such dividend, which is deducted from the fund’s NAV. The dividend on mutual fund taxability is also indirectly borne by investors, only in terms of a reduction in fund NAV.
Take an informed decision for a tax-efficient financial plan. Happy investing!
Note: The tax provisions, as mentioned in the article, are updated as per the Finance (No. 2) Act, 2019. However, the tax incidence will be as per the prevailing tax laws as on the date of redemption of the mutual fund units and not as per the tax laws prevailing on the date of investment.
Disclaimer-
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
To know about the KYC documentary requirements and procedure for change of address, phone number, bank details, etc. please visit https://www.utimf.com/servicerequest/kyc. Please deal with only registered Mutual funds, details of which can be verified on the SEBI website under "Intermediaries/market Infrastructure Institutions". All complaints regarding UTI Mutual Fund can be directed towards service@uti.co.in and/or visit www.scores.gov.in (SEBI SCORES portal). This material is part of Investor Education and awareness initiative of UTI Mutual Fund.