Income Tax Filing for Mutual Funds: A Complete Guide

What are the Types of Income From Mutual Funds?

Before we move ahead and discuss ‘how to show mutual fund investment in ITR,’ let us first understand the types of incomes that arise from a mutual fund.

Tax on Mutual Fund Dividends

Any dividend from an investment made in an equity mutual fund must be declared under ‘Income from other sources in the ITR. Such income is taxable in the receiver’s hands per the applicable slab rates. The taxpayer is also eligible to claim a deduction of up to 20% of the dividend income for the interest expense incurred to earn the dividend.10% TDS on dividends over ₹5,000 in a financial year.

Tax on Capital Gains on Mutual Funds

Capital gains are the profits made when units of a mutual fund are sold or switched between schemes at a price greater than their cost. The taxability depends on the holding period:

Equity Mutual Funds (Investing 65% and more in listed equities)

• Short-Term Capital Gains (STCG): If sold within one year or less, charged at 20%.
• Long-Term Capital Gains (LTCG): On its sale after one year, income in excess of ₹1.25 lakhs will be charged at 12.5% (without indexation).

Debt Mutual Funds (Altered from April 1, 2023)

• Gains on debt mutual funds, acquired on or after April 1, 2023, regardless of the holding period, are taxed at slab rates.
• Gains on debt mutual funds, acquired before April 1, 2023, are taxed at 12.50% (without indexation), if they are held for more than 12 months.
• Previously, long-term capital gains (LTCG) on debt funds with more than three-year holding were charged at 20% with indexation relief. Not anymore.

Hybrid or Balanced Funds

• If they are exposed to more than 65% equity, they will be treated as equity funds.
• If they are exposed to more than 65% debt and money market instruments, they will be treated as debt funds.
• In any other case, they will be treated as normal funds and taxed at 12.50%, if they are held for more than 24 months or at slab rates if held for 24 months or less.

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How Are Mutual Fund Investments Taxed in India?

Income Tax On Mutual Funds

Investing in mutual funds can yield returns either as dividends or capital gains. The taxation of these returns depends on the type of mutual fund and the holding period.

Equity-Oriented Mutual Funds

Equity-oriented mutual funds have at least 65% of their portfolio invested in Indian-listed equity. The tax treatment for these funds varies based on the holding period. If the holding period is less than one year, the returns are considered short-term capital gains (STCG) and are taxed at 15%. If the holding period exceeds one year, the returns are typed as long-term capital gains (LTCG) and are taxed at 10%. Additionally, there is an exemption of up to ₹1,00,000 on LTCG, meaning tax at 10% is only calculated on gains above ₹1,00,000.

Examples of equity-oriented funds include tax saver funds, index funds, large and mid-cap funds, and flexi cap funds.

Non-Equity Oriented Mutual Funds

Non-equity mutual funds have less than 65% exposure to Indian-listed equity shares. The tax treatment for these funds also depends on the holding period. If the holding period is less than three years, the returns are considered short-term capital gains and are taxed according to the individual's income tax slab. If the holding period exceeds three years, the returns are classified as long-term capital gains and are taxed at 20% with indexation benefits.

Examples of non-equity mutual funds include gold funds, low-duration funds, and US opportunity funds.

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What are the Rules to Disclose Mutual Fund Income in ITR?

Given below are the rules to disclose the mutual fund income in ITR -

Dividend Income

Whether the dividend is received from a debt mutual fund or an equity mutual fund, it is considered as the investor’s income and added to his total income under the head income from other sources. A salaried individual can disclose such income in ITR-1 under ‘Income from other sources.’

Income From Sale

Taxation and disclosure of any income arising from the sale of mutual funds depend on the nature of the mutual fund and its holding period.

Short-term capital gains

• Debt Mutual funds - If the units of a debt mutual fund are redeemed or sold within 36 months of purchasing, they are known as short-term capital gains. These gains are added to the investor’s total income and charged to tax accordingly.
• Equity Mutual Funds - If the equity mutual funds purchased are sold within 12 months of the date of purchase, they are considered short-term capital gains and are chargeable to tax at 15%

Long-term Capital Gains

• Debt Mutual Funds - Debt funds sold or redeemed after 36 months from the date of purchasing them are termed long-term capital gains. Such gains are chargeable to tax at the rate of 20% after indexation.
• Equity Mutual Funds - Gains from the sale of equity mutual funds after 12 months of purchasing them are known as long-term capital gains. Such gains are exempt up to ₹1,00,000, and the remaining amount is chargeable to tax at 10%.

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Which ITR to File for Income From Mutual Funds in ITR?

Any person earning any capital gain during the financial year has to file either ITR-2 or ITR-3. Capital gains arising from mutual funds are taxed only in the year in which its units are redeemed. Taxpayers having capital gains during a year are required to file ITR-2.

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How to Report Mutual Fund Income in ITR?

Now that you know about the types of mutual fund earnings and which ITR to file, you must be thinking about how to show mutual fund investment in ITR. Follow the below-mentioned steps to show mutual fund income in ITR -

• Step 1. Visit the income tax department's official website and log in with your ID and password.
• Step 2. Select the e-file option. Click on Income Tax Returns > File Income Tax Returns.
• Step 3. Now, select the type of form, status, and assessment year. Select ‘taxable income is more than exemption limit’ as the reason.
  • ITR-2: For individual taxpayers with capital gains in mutual funds.
  • ITR-3: For business taxpayers with capital gains.
  • ITR-1: Not to be used if there are tax payable capital gains.
• Step 4. Select ‘General’ on the first page and ‘Income Schedule’ on the next page. Now, select ‘Schedule capital gains’ and the type of capital asset redeemed from the drop-down menu.
• Step 5. Capital gains can be either long-term or short-term in nature.
  To report short-term capital gains, click on ‘Add details’ and mention the aggregate amount you received from the sale of short-term capital assets and the acquisition cost.
  To report long-term capital gains, you must provide the details of every scrip separately. Once you have added all the required details in schedule 112A, click ‘Add.’
• Step 6. After you have confirmed all the schedules, you must review Part B TT1 and click on ‘Preview return.’
• Step 7. Provide the remaining details and click on ‘Proceed to Validation’ under the declaration tab. Once you have validated your ITR, the next step is to verify it. You can either send a signed ITR-V to the Income Tax Department or file it electronically. You can take a maximum of 120 days for verification after filing the ITR.

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Mistakes to Avoid while Filing ITR for Mutual Funds

• Missing to report capital gains on SIP redemptions.
• Missing to report dividend income and receiving a tax notice.
• Inappropriately choosing the wrong ITR form.
• Not cross-verifying and e-filing returns within the due date.
• Missing to deduct TDS in calculating tax liability.

Understanding the taxation of mutual funds helps investors make informed financial decisions. By having the right tax filing strategy, reporting exemptions, and avoiding potential mistakes, investors can stay compliant as well as optimize tax outflow.

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