Taxation
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 | ||
| Equity funds | Less than 12 months | Long term12 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.
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. 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.
Just in: 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.
For 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 a flat short-term capital gains tax (SCGT) rate of 15%
Budget April 2020 proposals
The DDT on dividends was abolished on 1 April 2020, therefore investors will be taxed on any dividends received after that date. On April 1, 2020, mutual fund dividends will be subject to a TDS under the Finance Act, 2020. Dividends given from a firm or mutual fund that exceed Rs 5,000 are subject to a 10% TDS.
Individuals who receive dividends from a company or mutual fund and whose expected annual income is less than the exemption limit can submit form 15G to the firm or fund.
A senior citizen with no expected annual tax liability has to provide the corporation disbursing a dividend with Form 15H.
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.