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Save Upto Rs. 45,000 Taxes by Investing in ELSS

Whenever there will be income, there will be tax. Even though you can minimise the tax that you pay, there is no escaping it. The gains that you earn from your mutual fund investments are also a form of income (capital gains) and they too are taxed (capital gains tax). The taxation on mutual fund gains vary as per the holding period and depending on the type of mutual fund.

The holding period of mutual fund units can be short-term or long-term. The longer you hold a mutual fund, the more tax-efficient your investments become. In case of debt mutual funds, long-term is defined as a period of 36 months and more. In case of equity mutual funds and balanced mutual funds, long-term is a period of 12 months and more. A period of less than 36 months for debt funds and less than 12 months for equity and balanced funds is defined as short-term.

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 that we understand how short-term and long-term is defined, let’s see how short-term gains and long-term gains are taxed on different types of mutual funds.

tax on mutual funds

Taxation on debt funds

Long-term gains, which is gains on debt fund units held for over 36 months, are subject to long-term capital gains tax (LCGT) 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 the tax on debt fund gains to come down significantly. Read this article to understand how indexation works.

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.

Taxation on equity funds

Gains on equity funds qualify as long-term gains after the units have been held for a period of 12 months. Long-term gains from equity funds are completely tax-free. This includes tax-saving mutual funds–ELSS funds. This means that if you hold your equity fund investments for over a year, you don’t have to pay any long-term capital gains tax (LCGT) on the gains you earn.

Short-term gains from equity funds, if the units are redeemed before 12 months, are taxed at a flat short-term capital gains tax (SCGT) rate of 15%.

Taxation on 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 equity funds.

Taxation on different types of mutual funds
Short-term capital gains tax Long-term capital gains tax
Equity mutual funds 15% Zero
Balanced mutual funds 15% Zero
Debt mutual funds As per tax slab 20% after indexation

How are SIPs taxed?

An SIP or a systematic investment plan is 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 also gains from mutual funds and 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. For example, let’s suppose you begin an SIP of ₹10,000 a month in an equity fund for 12 months. Your 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 sale of debt fund units.

This is how gains from different types of mutual funds are taxed. As mentioned earlier, the longer you hold onto your mutual fund units, the more tax-efficient they become as tax on long-term gains is much lesser, even zero, than tax on short-term gains.

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