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How Mutual Funds are Taxed

We think about taxes on everything we do, whether it is property or merely swiping a credit card. Then just imagine how much one is supposed to consider when it comes to the taxes on investing.

But most times, you know what happens? Most people forget about these taxes. Let me tell you why.

Firstly, when it comes to investing many people do not know where to start, and the rest think it is easier to save rather than invest. But are we not past that? I do not have to put it in words because we all know that just saving is not going to do the job, and investing is as important.

Right now, all of us are familiar with the fact that hustles are good, but they do not always show results. So we need to work smart along with working hard on the sidelines.

This being said, mutual funds are on top of the list when it comes to investments and they help to achieve financial bars, but did you know they are also taxed as efficient instruments? If not, you will find out here.

You May Read: Guide to Taxability of Trust in India

Returns of Mutual Funds

Cutting straight to the point, they are of two types – dividends and capital gains. Dividends are what are known as payouts of profit of the company, and a capital gain is a profit that has been realized by the investor while selling the bought security at a greater price.

Tax on the Mutual Fund Returns

Tax on Dividends or Dividend Distribution Tax

Dividends paid by any mutual fund scheme are taxed traditionally, according to adjustments announced in the Union Budget 2020. Dividends received by investors, in other words, are added to their taxable income and taxed at their respective income tax slab rates.

Dividends were previously tax-free in the hands of investors since corporations paid dividend distribution tax (DDT) before sharing earnings with investors in the form of dividends. Dividends (received from domestic enterprises) of up to Rs 10 lakh per year were tax-free in the hands of investors under this regime. Dividends over Rs 10 lakh per fiscal year were subject to a 10% dividend distribution tax.

Tax on the Capital Gain

The tax rate on mutual fund capital gains is determined by the holding period and kind of mutual fund. The holding period is the length of time that a mutual fund unit was held by an investor. In layman’s terms, the holding period is the time elapsed between the purchase and sale of mutual fund units.

A Summary of Mutual Fund Taxes and Factors

1) For an Indian Resident

There are two types of funds: Equity Funds and Non-Equity Funds.

Holding Period and Capital Gains:

Equity Funds = Short Term Capital Gains and Long Term Capital Gains held for a year or less and held for a year or more, respectively.

Non-Equity Funds = Short Term Capital Gains and Long Term Capital Gains held for 3 years or less and held for 3 years or more, respectively.

Okay, this might have seemed a little simple, but there is more to it, and it is not over yet. So buckle up because we are going in a little deep.

You May Read: What is Fund of Funds?

Tax on the Short-Term and Long-Term Gains of Mutual Funds

1. Tax on Capital Gains of Equity Funds

Equity funds are mutual funds with a portfolio equity exposure greater than 65%. As previously stated, when you redeem your equity fund units during a one-year holding period, you realize short-term capital gains. These gains are taxed at a flat rate of 15%, regardless of your income tax level.

When you sell your stock fund units after a year or longer of holding, you realize long-term financial gains. Capital gains of up to Rs 1 lakh per year are tax-free. Any long-term capital gains over this ceiling are subject to LTCG tax at a rate of 10%, with no indexation advantage.

2. Tax on the Capital Gains of Debt Funds

Debt funds are mutual funds with a debt exposure of more than 65% of their portfolio. As shown in the table above, if you redeem your debt fund units within three years, you will receive short-term capital gains. These profits are added to your taxable income and taxed at the rate specified in your income tax slab.

Long-term capital gains are realized when you sell debt fund units after a three-year holding period. After indexation, these profits are taxed at a flat rate of 20%. In addition, you must pay the applicable cess and surcharge on tax.

3. Tax on Capital Gains of Hybrid Funds

The tax rate on capital gains on hybrid or balanced funds is determined by the portfolio’s equity exposure. If the equity exposure exceeds 65%, the fund plan is taxed like an equity fund; otherwise, the taxation rules for debt funds apply. As a result, it is critical to understand the equity exposure of the hybrid scheme in which you are investing; otherwise, you may be in for a rude surprise when it comes time to redeem your fund units.

4. SIP Taxes

Systematic investment plans (SIPs) are a type of mutual fund investment. They are constructed in such a way that investors can put a small sum in a mutual fund scheme regularly. Investors are given the option of determining the frequency of their investments.

It can be done on a weekly, monthly, quarterly, bi-annually, or annual basis. With each SIP installment, you buy a set amount of mutual fund units. The redemption of these units is done on a first-come, first-served basis. Assume you make a one-year SIP investment in an equities fund and decide to redeem your full investment after 13 months.

In this situation, the units purchased first through the SIP are kept for a lengthy period (over a year), and you realize long-term capital gains on these units. If your long-term capital gains are less than Rs 1 lakh, you are not required to pay any tax.

5. Securities Taxes

Aside from the dividend and capital gains taxes, there is another tax known as the Securities Transaction Tax (STT). When you acquire or sell mutual fund units of an equity fund or a hybrid equity-oriented fund, the government (Ministry of Finance) charges an STT of 0.001%. The selling of debt fund units is exempt from STT.

Mutual Funds Tax Slab Summary for 2022

Equity Funds

  • Short term capital gain = 15% + cess + applicable surcharge.
  • Long Term Capital Gain for Upto 1 Lakh = 0%
  • Long Term Capital Gain for above 1 Lakh = 10% + cess + applicable surcharges.
  • Dividend = NIL

Non-Equity Funds

  • Short-term capital gain = According to the tax rate of the investor.
  • Long Term Capital Gain = 20% with indexation.
  • Dividend = NIL

Conclusion

We have discussed every aspect of tax that could be on your mutual funds, so while you file your income tax return, you can carefully go through all of the mutual fund redemptions and calculate your gains for a financial year.

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