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Mutual Fund Taxation – How mutual funds are taxed?

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The primary aim of any investment is to earn make money out of it. Investing in mutual funds generates capital gains, which can be taxable. In this article, let us explore the tax implications of various mutual fund types. 

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

 

1. Mutual Funds Holding Period  

We all invest to earn income on our investments in the form of interest, dividends or capital gains. And where there is income, there is income tax. The tax you need to pay on capital gains largely depends on the time for which you stay invested in the respective schemes. This is holding period of mutual funds.

2. Types of holding periods

a. Long-term holding period

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. So, long-term capital gains tax or LTCG applies to those investments. A holding period of 36 months or more is regarded as long-term for debt funds.

b. Short-term holding period

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. Therefore, short-term capital gains tax applies to income made from any scheme held for less than 36 months or 3 years. Some examples for short-term schemes include treasury bill, 91-day bonds etc.

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.

 

3. Taxation on Mutual Funds

a. Tax-Saving Equity Funds

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

ELSS comes up with a lock-in period of 3 years. This means, you cannot redeem your units before expiration of 3 years. After redemption, 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 taxable 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 taxable at the rate of 10% without the benefit of indexation. Government introduced this in Budget 2018.

 

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.

 

There is a 15% tax on short-term gains from equity funds, if the units are redeemed before 12 months. There has been no change 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 to bring down the quantum of capital gains. You must add short-term gains from debt funds to your overall income. They 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.

Mutual Fund Taxation


e. SIPs

An SIP or a systematic investment plan is to invest a fixed amount in a mutual fund in a periodic manner. An SIP can be daily, weekly, fortnightly, monthly or even quarterly. As detailed above, gains from SIPs are taxable 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.

For instance, 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.

f. Securities Transaction tax (STT)

Apart from all the above, 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.

4. Conclusion 

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

Do you find all these tax facts too taxing? Many do. That is why Cleartax has an LTCG tax filing and advisory service that you can make use of every financial year. You are one click away from simplifying your taxes.