Mutual funds are popular financial products that pool money from investors and invest in stocks on their behalf. Capital gains apply to profits you make from your mutual fund investments. Tax on mutual funds is based on profits you make. Depending on the holding duration of mutual fund units, capital gains from selling them are categorized as short-term or long-term. However, the duration of investments to determine the tax on mutual funds varies across funds. For equity funds, short-term capital gains (STCG) at the rate of 20% will apply to gains from units held up to one year, while mutual fund units held for more than one year will attract long-term capital gains (LTCG) at the rate of 12.5% if the gains exceed Rs. 1.25 lakh a year. Let us understand the tax implications for different types of mutual funds in detail.
What is tax on mutual funds?
If you invest in or plan to invest in mutual funds, you need to know how your gains will be taxed. Gains and profits from mutual funds are taxed, just like gains and profits from most other types of investments. Because taxes are hard to avoid, it’s a good idea to know the rules about taxes on mutual funds before you buy.
Learning about tax on mutual funds can help you plan your investments so that you pay less in taxes generally. Of course, there are times when you can also get tax breaks. So, if you want to invest in mutual funds, ensure you know the rules about taxes on mutual funds.
What are the factors that determine tax on mutual funds?
You can learn more about how mutual funds are taxed by assessing the factors that affect them. These are the main things that impact mutual fund taxation:
- Types of funds: Different types of mutual funds have different tax rules. Types of funds include stock mutual funds, debt mutual funds, hybrid mutual funds, and liquid funds.
- Dividend: When mutual fund companies make money, they give some of it back to owners as a dividend.
- Capital gains: The return investors make when they sell their mutual fund units for more than what they paid for them are called capital gains.
- Holding period: The time between when you buy mutual fund shares and when you sell them. Tax on mutual funds in India mandates that if you hold on to your investment for an extended period, you will only have to pay a small amount of tax. So, the duration of time you hold on to your mutual fund units impacts the capital gains tax that you pay.
How do you earn returns in mutual funds?
When you invest in mutual funds, you can make money in two ways: cash gains and profit. The money that was put into stocks gives dividends based on how much money they made on the market. You can earn if you decide to get these rewards or mutual fund tax benefits. However, you can also reinvest your dividends which will help your money grow through the power of compounding.
Capital gains on mutual funds are another way to make money. When you buy units of a mutual fund on the stock market, they cost a certain amount. If the price of those units goes up in the future, you can sell them and make a profit.
Taxation of dividends offered by mutual funds
Union Budget 2020 introduced taxes on dividends from mutual fund schemes. Essentially, dividends earned by mutual fund investors will be added to their taxable income and taxed at their respective slab rates. Until then, dividends were not taxable in the hands of investors.
Taxation of capital gains offered by mutual funds
The holding period and the type of fund will decide the taxation rate of capital gains made from mutual fund investments. For equity funds, short-term capital gains will apply to units held for less than 12 months, while long-term capital gains will apply to investments held for more than 12 months. Capital gains from selling debt fund units are always categorized as short-term irrespective of the holding period. Capital gains from hybrid debt-oriented funds are taxed as short-term, while hybrid equity-oriented funds will attract short-term capital gains for investments held shorter than 12 months. At the same time, hybrid equity-oriented funds held for more than 12 months will attract long-term capital gains tax.
Taxation of mutual funds
People who invest in mutual funds need to think about how their profits will be taxed. Capital gains are profits that investors make when they sell mutual fund units. There are two types of gains: short-term and long-term. The difference between the two is how long buyers hold on to the units. Now, let us understand how capital gains are taxed for different types of mutual funds.
Taxation of capital gains of equity funds
Taxes on mutual funds apply to most categories of funds, including equity funds. Equity funds fall under categories such as large-cap, mid-cap, and small-cap, not to mention Aggressive Hybrid and Arbitrage Funds. If you sell your equity fund holdings after 12 months, you need to pay long-term capital gains (LTCG) tax at the rate of 12.5%. However, LTCG will kick in only if you have gains above Rs. 1.25 lakh. However, you will have to pay short-term capital gains (STCG) tax at the rate of 20% if you sell equity funds before 12 months.
Taxation of capital gains of debt funds
Debt mutual funds invest about 65% in debt instruments. Gilt Funds and Liquid Funds belong to this category. If you invested in a debt fund after April 1, 2023, the profit you make will be added to your income and you will have to pay tax at your slab rate no matter the duration of investment. However, if you had invested before April 1, 2023, there could be two situations: For any sale made before 23 July, 2024, LTCG (more than 36 months) at the rate of 20% will kick in, with indexation benefit. Separately, if you sold after 23 July, 2024, LTCG (less than 24 months) will apply at the rate of 12.50%, while short-term gains will be taxed according to your slab rate.
Taxation of capital gains of hybrid funds
Mutual fund taxation rules apply to hybrid funds also. Hybrid funds invest between 35% to 65% of their corpus in Indian equities. If you sold your hybrid fund units before 23 July 2024, LTCG (more than 36 months) will apply at the rate of 20% with indexation benefit and STCG will be taxed at the slab rate. However, if you sell the units after 23 July 2024, LTCG (less than 24 months) kicks in at the rate of 12.50% and STCG at the slab rate will apply.
Taxation of capital gains when invested through SIPs
With Systematic Investment Plans (SIPs), you can put small amounts of money into mutual funds every month. The SIP tax depends on how long you’ve had the account. You pay less tax on long-term capital gains, which is the profit you make from investing for more than a year. The short-term capital gain you make is taxed at a high rate if you have stayed invested for less than a year. However, if long-term capital gains are below Rs. 1.5 lakh, you don’t have to pay any tax.
Securities Transaction Tax (STT)
The STT is a type of financial transaction tax. Any time you buy or sell shares traded on one of India’s stock exchanges, you need to pay a tax known as STT. The Stocks Transaction Tax Act (STT Act) sets the rules for STT. The STT Act lists the different types of taxable stock transactions or trades that are subject to STT.
Securities that are taxed include stocks, bonds, and units of equity-oriented investment funds. STT—at the rate of 0.001% of the transaction value—kicks in when you buy or sell units of equity funds or hybrid equity-oriented funds. In some cases, shares that were sold during an initial public offering (IPO) and are not yet traded on a stock exchange are added to the list. STT is an extra fee that needs to be paid on top of the transaction value. This means that the transaction value goes up.
Conclusion
The type of fund and the duration of investment determine how the tax on mutual funds is calculated. Tax calculation can be tricky, even though it’s not hard to do the math. Pay attention to the tax rules for different funds, whether they hold stocks, bonds, or hybrid. Moreover, it helps you understand your taxes better and enables you to make prudent investment decisions.
Frequently Asked Questions
- What does STT mean for mutual funds?
Equity funds are mutual funds that have more than 65% of their assets in stocks. These funds could be large-cap, mid-cap, small-cap, equity-linked savings schemes (ELSS), or other types. Buyers and sellers of mutual fund units are liable to pay STT, which is 0.001% of the transaction value.
- Which are the four types of mutual funds?
Mutual funds can be broadly categorized into four groups: Equity Funds, Debt Funds, Money Market Funds, and Hybrid Funds.
- How do you find TDS in mutual funds?
As per the AMFI website, there shall be no tax deductible if dividend income paid/credited in respect of units of a mutual fund is below Rs. 5,000 in a financial year.
- How much capital gain is tax-free?
Assets that are based on stocks: LTCG exemptions go up to Rs. 1.25 lakh. Small investors notably benefit from the fact that capital gains up to Rs. 1.25 lakh are not taxed in a financial year. For non-equity assets, there is no such cap on the amount that is not taxed. After indexation, all gains are taxed.
- What is the easy way to figure out capital gains tax?
To find capital gains, use the formula net capital gain = capital income – cost base. Once that happens, that amount is added to your taxable income for that year and taxed at the slab rate.
