While creating an investment portfolio, it helps to know the tax incidence of different investments. It is usually advised to compare investments in terms of post-tax returns instead of absolute returns. This article discusses key information related to tax on mutual funds in India.
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Below are the provisions on taxation on mutual funds:
Point of taxation for mutual fund investments
Investors must pay tax on mutual fund investments once they redeem units and realise profits. Further, a switch transaction is considered the equivalent of a redemption transaction, and investors must pay taxes on the gains from the mutual fund units switched out.
Classification of mutual funds for taxation purposes
Income tax rules require that mutual fund schemes be classified into two categories – equity-oriented mutual funds and other than equity-oriented mutual fund schemes. Equity-oriented mutual fund schemes invest at least 65% or more of their net assets in listed equity securities of domestic companies. All other mutual fund schemes, such as debt funds, gold funds, etc, fall under 'other than equity-oriented mutual fund schemes'.
The categorisation of capital gains from mutual funds
On realisation of the capital appreciation in the mutual fund schemes, it is taxed as 'Income from Capital Gains,' which may be categorised into STCG (Short Term Capital Gains) and LTCG (Long Term Capital Gains) tax on mutual funds based on the holding period of such mutual fund investments by the investors. As such, if the investor has held the investments in equity-oriented funds for 12 months or less than that, the gains from such investments will be classified as STCG, and for mutual fund investments with a more extended investment period, gains will be classified as LTCG on mutual funds.
Such a period for classification of gains from other than equity oriented mutual fund schemes is more than 36 months. Thus, returns from other than equity-oriented mutual funds with an investment period of 36 months or less are classified as STCG, while such gains may be classified as LTCG for the more extended holding period.
The investors are liable to pay tax as per the rates below:
1. Equity oriented mutual funds
STCG from equity-oriented mutual fund schemes are taxed at 15% (plus applicable surcharge and cess). On the other hand, LTCG is taxed at 10% (plus applicable surcharge and cess) for gains exceeding ₹1 lakh a financial year in respect of LTCG from equity shares and equity-oriented mutual funds, taken together. Further, no indexation benefit is allowed in respect of LTCG as per the new income tax rules. As such, the capital gains may be directly computed by deducting the invested amount from the redemption value. Securities Transaction Tax also applies to the redemption and switch of equity-oriented schemes.
2. Other than Equity Oriented Mutual Funds
The investors are liable to pay income tax at the regular tax rates as applicable to them in respect of STCG from other than equity oriented mutual funds. LTCG from such funds for resident investors is liable for tax at 20% (plus applicable surcharge and cess) along with the benefit of indexation to the investors. Thus, while STCG is calculated by deducting the cost of investment from the redemption value, LTCG is calculated by subtracting the indexed cost of investment amount from the redemption value instead of the actual amount invested. This may help the investors effectively lower the tax incidence below the applicable tax rate of 20%. For non-resident investors, long-term capital gain on the transfer of listed units is taxable @20% and 10% on unlisted units if the non-resident is not a company or a foreign company and without applying the indexation provisions. DTAA provisions may also be applicable to non-resident investors.
3. Taxation of Dividend
While the dividend distributed was subject to deduction Income/Dividend Distribution Tax (DDT) by the concerned mutual fund, the dividend income was exempt from investors' hands until the financial year 2019-20. However, pursuant to the Finance Act 2020, from the financial year 2020-21income tax on dividend income is chargeable in the hands of investors. Pursuant to the Finance Act 2020, mutual funds are no longer liable to deduct DDT from the financial year 2020-21. As such, the dividend income is taxable at the regular tax rates as applicable to the investor. Further, TDS provisions have also been introduced regarding such dividend income. The investors may claim the credit of such TDS in their ITRs.
4. Tax Benefits under Section 80C
Mutual funds also provide an opportunity for the investors to save taxes with regards to the eligible tax-saving investments under ELSS. ELSS is a particular category of mutual fund scheme which, subject to certain conditions, including a lock-in period for 3 years from the date of investment, renders tax benefits. Contributions made by individuals and HUFs in the ELSS are eligible for deduction of the amount paid subject to a maximum of ₹1,50,000/- in a financial year from the total income under Section 80 C of the Income Tax Act. This lock-in period of 3 years is amongst the lowest lock-in periods available under the various tax saving options available under Section 80C of the Income Tax Act. However, investors who opt for the new income tax regime under section 115BAC of the Income Tax Act, introduced by the Finance Act 2020, will not be eligible to avail the benefit of tax benefit under section 80 C of the Income Tax Act.
With the knowledge of taxation on mutual funds, the investors may be expected to make an informed decision in this regard.
5. Securities Transaction Tax (STT)
For certain funds, the Ministry of Finance levies a 0.001% tax as STT. This tax is levied when investors choose to buy or sell equities or equity-oriented funds. This tax is only levied in the case of equities and is not relevant to debt funds.
Tabular summary of taxation on equity and other mutual fund schemes:
I. TAX RATES FOR MUTUAL FUND INVESTORS
*With indexation $Without indexation@IDCW = Income Distribution cum Capital Withdrawal
*With indexation $Without indexation@IDCW = Income Distribution cum Capital Withdrawal
Tax & TDS are subject to applicable Surcharge and Health & Education Cess at the rate of 4%.
Source : Association of Mutual Funds in India
Note: The tax rates as mentioned in the article are for illustrative purposes only and are updated as per Finance Act 2020. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale/switch and not on the date of investment.
Disclaimers:
The limited information set out above is included for general information purposes only for the investors of the UTI Mutual Fund Schemes and is not exhaustive and does not constitute legal or tax advice. In view of the individual nature of the tax consequences, each investor is strongly advised to consult his or her or their own tax consultant with respect to specific tax implications arising out of their participation in the Scheme. Income Tax benefits to the mutual fund & to the unit holder is in accordance with the prevailing tax laws/finance act 2020. Any action taken by you on the basis of the information contained herein is not intended as on offer or solicitation for the purchase and sales of any schemes of UTI mutual Fund. Please read the full details provided in SID and SIA carefully before taking any decision.
UTI AMC Ltd is not an investment adviser, and is not purporting to provide you with investment, legal or tax advice. UTI AMC Ltd or UTI Mutual Fund (acting through UTI Trustee Company Pvt. Ltd) accepts no liability and will not be liable for any loss or damage arising directly or indirectly (including special, incidental or consequential loss or damage) from your use of this document, howsoever arising, and including any loss, damage or expense arising from, but not limited to, any defect, error, imperfection, fault, mistake or inaccuracy with this document, its contents or associated services, or due to any unavailability of the document or any part thereof or any contents or associated services.