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Mutual Fund Taxation – How mutual funds are taxed?

Investing in mutual funds generates capital gains which can be taxed. Read on to know more about Mutual Fund Taxation.

  1. Mutual Funds Holding Period and Taxation
  2. Taxation on 
    1. Tax-Saving Equity Funds
    2. Non-tax Saving Equity Funds
    3. Debt Funds
    4. Balanced funds
    5. SIPs
  3. Conclusion

1. Mutual Funds Holding Period  

The basic motivation behind investing in mutual funds is to earn interest/dividends and capital gains. You need to know that these capital gains are taxed by the income tax authorities. The amount of tax to be paid on capital gains depends on the time for which you stay invested in them. It is referred to as the holding period of mutual funds.

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The holding period of mutual fund units can be short-term or long-term. In case of equity mutual funds and balanced mutual funds, a holding period of 12 months or more is regarded as long-term. In case of debt mutual funds, a holding period of 36 months or more is regarded as long-term. A holding period of less than 36 months for debt funds and less than 12 months for equity and balanced funds is defined as short-term.

The following table gives a glimpse of holding period classification of mutual funds:

 

 Funds Short-term Long-term
Equity funds Less than 12 months 12 months and more
Balanced funds Less than 12 months 12 months and more
Debt funds Less than 36 months 36 months and more

 

Now let’s have a look at the taxation of short-term gains and long-term capital gains on different types of mutual funds.

 

2. Taxation on Mutual Funds

a. Tax-Saving Equity Funds

Equity-Linked Saving Scheme (ELSS) are the most efficient tax-saving instruments under Section 80C of the Income Tax Act 1961. These are diversified equity funds which invest in equity shares of companies across market capitalization.

ELSS comes up with a lock-in period of 3 years. It means that once you invest in ELSS, you cannot redeem your units before expiration of 3 years. You can claim a tax deduction of up to Rs 1.5lakh and save taxes up to Rs 45000 by investing in ELSS.

Upon redemption after 3 years, the long-term capital gains (LTCG) up to Rs 1 lakh are tax-free in your hands.  LTCG in excess of Rs 1 lakh is taxed at the rate of 10% without the benefit of indexation.

Invest in top-performing ELSS funds in a paperless and hassle-free manner on ClearTax

 

Tax Saving Equity Fund

b. Non-tax Saving Equity Funds

Long-term capital gains (LTCG) on non-tax saving equity funds of up to Rs 1 lakh are tax-free in your hands.  LTCG in excess of Rs 1 lakh is taxed at the rate of 10% without the benefit of indexation.

 

Budget 2018 Proposals

1st February 2018

  • To tax Long-term capital Gains on sale of Equity shares/units of Equity oriented Fund if more than Rs 1 lakh at @ 10% without the benefit of indexation.
  • Relief to existing investors to exempt amount of capital gains up to 31 Jan 2018. The amount of Gains made thereafter this cut-off date will be taxed.

Example:

Mr. A purchased shares for Rs. 100 on 30th September 2017 and sold them on 31st December 2018 at Rs 120. The Value of the Stock was Rs. 110 as on 31st January 2018. Out of the capital gains of Rs. 20 (i.e 120-100), Rs. 10 (i.e 110-100) is not taxable. Rest Rs. 10 is taxable as Capital gains @ 10% without indexation.

 

Short-term gains from equity funds, if the units are redeemed before 12 months, are taxed at the rate of 15% (No changes in the Budget 2018 in this regard)

Invest in top-performing Equity funds in a paperless and hassle-free manner on ClearTax.

c. Debt Funds

Long-term capital gains on debt fund are taxed at the rate of 20% after indexation. Indexation is a method of factoring in the rise in inflation between the year when the debt fund units were bought and the year when they are sold.

Indexation allows to inflate the purchase price of debt funds so as to bring down the quantum of capital gains. come down significantly. Short-term gains from debt funds are added to your income and are subject to short-term capital gains tax (SCGT) as per the income tax slab you fall under.

d. Balanced funds

Balanced funds are equity-oriented hybrid funds that invest at least 65% of their assets in equities. This is why their tax treatment is exactly the same as non-tax saving equity funds.

 

Taxation on different types of mutual funds
Short-term capital gains (STCG) tax Long-term capital gains (LTCG) tax
Equity mutual funds 15% 10% on LTCG in excess of Rs. 1 Lakh
Balanced mutual funds 15% 10% on LTCG in excess of Rs. 1 Lakh
Debt mutual funds As per tax slab 20% after indexation

e. SIPs

An SIP or a systematic investment plan is the method of investing a fixed amount in a mutual fund in a periodic manner. An SIP can be fortnightly, monthly, quarterly or yearly. Gains made from SIPs are taxed as per the type of mutual fund and the holding period. For the purpose of taxation, each individual SIP is treated as a fresh investment and gains on it are taxed separately.

Suppose you begin an SIP of ₹10,000 a month in an equity fund for 12 months. Each individual SIP is considered to be a fresh investment. Hence, after 12 months, if you decide to redeem your entire accumulated corpus (investments plus gains), all your gains will not be tax-free. Only the gains earned on the first SIP would be tax-free because only that investment would have completed one year. The rest of the gains would be subject to short-term capital gains tax.

Apart from these, there is also something called the Securities Transaction Tax (STT). An STT of 0.001% is levied by the fund company itself when you sell units of an equity fund or balanced fund. There is no STT on the sale of debt fund units.

3. Conclusion 

Thus, the longer you hold onto your mutual fund units, the more tax-efficient they become as the tax on long-term gains is much lesser than tax on short-term gains.

Too complex? Don’t worry. You can opt for the LTCG tax filing and advisory services that ClearTax offers for individuals with capital gains during the financial year.

 

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