Mutual Fund Taxation – How Mutual Funds Are Taxed?

What is Mutual Funds Taxation?

Whenever an individual/institution or a company invests in mutual funds, the profits earned on such an investment are taxable as capital gains. Mutual funds taxation in India refers to the tax-related provisions applicable to the profits from mutual funds. It is important first to understand the taxation on profits of mutual funds before deciding to invest.

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How to Determine Mutual Funds Taxation?

Mutual funds taxation in India depends on several factors. Below are the factors affecting taxation of mutual funds -

• Types of Funds - Tax is levied on both debt-oriented and equity-oriented mutual funds. The tax rates and tax provisions vary depending on the type of mutual fund.
• Period of Holding - The period of holding the mutual fund also affects the nature of the profit. For example, if a mutual fund is held for more than one year, it attracts LTCG; in case you hold it for 1 year or less, it attracts STCG.
• Capital Gains - When you sell a mutual fund on a profit, the profit earned is known as capital gain. Taxation of capital gains is different from dividends.
• Dividend - When the mutual fund house distributes a portion of the total profit among the investors, it is known as a dividend.

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What are the Types of Returns on Mutual Funds?

Mutual funds generate 2 types of returns, i.e., dividend income and capital gains. Let us understand them in detail -

Dividend - When the company decides to distribute the surplus profits among the investors or shareholders, the returns are known as dividends. In other words, a dividend is a part of the company’s profit paid to the shareholders. Dividends are taxed in the investor’s hands.

Capital gains - When an asset is sold for an amount higher than its purchase price, it leads to capital gains. In other words, any appreciation in the rates of mutual funds gives rise to capital gains. Investors are required to pay tax on capital gains.

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What is the Mutual Funds Taxation on Dividends?

Earlier, dividend income was not taxable in the hands of investors. The company used to pay dividend distribution tax before releasing the dividend amount to the shareholders.

However, after the amendment to Union Budget 2020, all dividend income is taxable in the hands of investors. The income is added to the total annual income of the shareholder and taxed as per the applicable slab rates.

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What is the Mutual Funds Taxation on Capital Gains?

If the rate of the mutual fund increases over the period for which the fund is held and is sold at a higher price than the purchase price, the gains arising thereof are known as capital gains. The taxation on capital gains largely depends on the holding period of the mutual fund. The period for which an investor holds the fund affects the tax rate on capital gains.

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Equity Funds

Mutual funds having 65% or more investment in Equity instruments are known as equity funds.

• If the holding period of your equity fund is up to or less than 1 year, it is taxed as short-term capital gains. Irrespective of your applicable slab rate, short-term capital gains attract a tax of @15% flat.
• If the holding period of your equity fund is more than 1 year, the gain on the sale of your investment will result in long-term capital gains. Long-term capital gains up to Rs1 lakh are free from tax. Any gains exceeding 1 lakh per annum are taxable at @10%.

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Debt Funds

Mutual funds having more than 65% debt component are known as debt oriented funds or hybrid funds.

• If you hold the debt funds for a period of 3 years or less, the gains arising from them are considered short-term capital gains. These short-term capital gains are added to the total annual income of the assessee and taxed at the applicable slab rates.
• Earlier to Finance Act 2023, If you sell the debt funds after holding them for 3 years, the gains from selling them are considered long-term in nature. These gains are taxed at flat 20% after the benefit of indexation or 10% without indexation.
• As per The Finance Act 2023 no indexation benefit is available to 100% debt oriented funds or funds having investment in equity instruments limited to 35%, irrespective of holding period. Gains arising from debt mutual funds will be added to your taxable income and taxed at normal tax slab rate. This will be applicable for FY- 2023-2024

Now that you know everything about the taxation on mutual funds and the tax rates, you can invest in the best mutual fund. Taxation on mutual funds can be a little complicated for laymen. Taking professional help can make it simple and quick. Hire a CA now!

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