How are Mutual Funds Taxed?
With so many different types of funds to choose from, mutual funds ensure that every type of investor can find a scheme that best meets their requirements. But, while people focus on factors like returns potential, historical performance, and the expense ratio, they often overlook the tax implications.
To make the right investment decision, something as crucial as mutual fund taxation cannot be neglected. Take a look at how different types of mutual funds are taxed in India.
Types of Mutual Funds
While there are different types of mutual funds, they are classified into three categories based on the allocation of a fund. These are:
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Equity Funds
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Debt Funds
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Hybrid Funds
| Type of Fund | Features | Taxation |
|---|---|---|
| Equity | Equity Funds are exchange-traded funds that allocate 65% or more of their funds to equity-oriented investments. | Taxed as per equity fund |
| Debt | Debt Funds are exchange-traded funds that allocate 65% or more of their funds to debt-oriented instruments | Taxed as per equity fund |
| Hybrid | Hybrid Funds balance their asset allocation between two or more asset classes. They can be broadly classified into debt-oriented hybrid funds or equity-oriented hybrid funds depending on their allocation.
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Taxed as per equity funds if they are equity-oriented and debt funds if they are debt-oriented funds. |
This distinction is vital as income tax on mutual funds depends on the fund category you invest in. Let us understand, in detail, how each of these mutual funds is taxed:
Equity mutual fund taxation
There are two different ways in which an investor earns returns from equity mutual funds - capital gains and dividends. When you invest in an equity mutual fund scheme, you get the option to either go with the growth (non-dividend) or dividend option. Taxation varies with both these options:
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Tax on Capital Gains
• With regards to taxation in equity funds, LTCG (Long-Term Capital Gains) is applicable for investments held over 12 months. STCG (Short-Term Capital Gains) is applicable if the investment is held for less than 12 months.
Equity funds attract LTCG tax at the rate of 10%, along with applicable cess and surcharge, if the gains are above Rs. 1 lakh in a year. There is no indexation benefit available in equity funds. Indexation helps you increase the purchase price of mutual funds concerning inflation. The STCG gains are taxed at 15%, along with the applicable cess and surcharge.
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Tax on Dividends
Before February 2020, the fund house was responsible for paying the DDT (Dividend Distribution Tax) of 10%, along with surcharge, to the government on behalf of the investor. But, Budget 2020 has abolished DDT. From April 2020, the fund house will not deduct DDT.
The dividend will be fully paid to the investor, after deducting applicable TDS, and the investor must pay tax on the dividends as per his/her income tax slab. Also, note that the tax mentioned above on mutual funds applies to ELSS (Equity Linked Savings Scheme) mutual funds.
Debt mutual fund taxation
The duration of LTCG and STCG vary between equity and debt funds.
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In debt funds, taxation on LTCG is applicable at the rate of 20% with indexation benefit for investments held for more than 36 months.
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The gains from investments held for less than 36 months are considered short-term gains. Such gains are added to the taxable income of the investor and taxed as per his/her tax slab.
Hybrid/Balanced Fund Taxation
The taxation of hybrid funds depends on the portfolio of the scheme. As mentioned above, if more than 65% of the portfolio holdings of a scheme are in equity instruments, it is considered as an equity-oriented fund and taxed as per the equity fund taxation policy.
If the scheme has less than 65% of its holdings in equity instruments, it is considered a debt fund and taxed accordingly. Even if a balanced fund has 50% investments in equity and 50% investments in debt, it will still be treated as a debt fund for taxation.
Tax-aware Mutual Fund investing
Taxation has a far-reaching impact on investments. So, it is always better to account for the effect of taxes on your investments to avoid any discrepancies in the future and better manage your investment journey.
Now that you know how income tax on mutual funds in India works, you can take an informed investment decision and select funds that best suit your investment profile and financial objectives.