Tax On Mutual Fund Returns, How Much, When and How?

Tax on mutual fund returns. How much, when and how? complete information.

In today’s time, mutual fund is one of the best means of investment. It is capable of giving you a good return which helps you in achieving your financial goals even with small amount of investment. But here it is also important to note that like other means of investment, mutual funds are also not exempt from tax, and if you are investing without knowing about the tax imposed on mutual funds, then you are not a conscious investor. Do not fall in the category of. Taxes on mutual fund investments can reduce the value of your investment, but if you invest wisely, you can also save on tax liability. How much tax is levied on Mutual Funds? Today we will know about at what rate it occurs and under what circumstances.

Factors determining tax on mutual funds

We get two types of income from mutual funds, capital gains and dividends and both of them come under the tax bracket. The percentage of tax rate depends on many factors like the type of mutual fund scheme in which the investment is made, the holding period, which tax bracket the investor’s income falls in, etc. If we want to understand the tax levied on mutual funds completely, then let us first know about the factors or facts on which the tax calculation depends. These factors are:

Dividend: The securities or assets in which mutual funds invest usually distribute a portion of the profits to investors. This profit share is called dividend. Dividends do a good job of providing the investor a source of regular income as well as partial income.

Capital Gains: The increase in the value of an investment as its holding period increases is called capital gains. When an investor sells his mutual fund unit, the tax charged on the profit made from it is called capital gains tax.

Types of fund: Mainly two types of securities are invested in mutual funds. Equity and Debt. In equity, shares and assets related to private sector and stock market are invested which have higher risk and higher returns. Whereas debt mutual funds invest in government securities, bonds and fixed income securities which offer low risk and low returns. Apart from this, there are many other types of fund schemes such as hybrid and tax saving schemes. The rates and conditions of all these taxes are different.

Holding time – Holding period: The tax charged on any investment also depends on its holding period i.e. for how long it has been invested in a fund.

Taxes levied on Mutual Funds

The tax imposed on mutual funds can be divided into mainly 5 parts.

Capital gains tax

Capital gains tax depends on the time period of mutual fund investment. This tax is calculated on whatever return you get on your investment. According to the period of holding mutual fund, it is divided into two parts. Short term capital gain – short term capital gain and long term capital gain – long term capital gain. It is also important to keep in mind that capital gains tax is applicable only when mutual fund units are sold/redemption is taken. If you have held your investment then you will not have to pay any tax no matter how much profit you make. For example, if you invested Rs 1000 in any of your funds and after one year you took redemption, its value was Rs 1100. In this case, you will have to pay capital gains tax only on the capital gain i.e. only Rs 100. This tax is applicable differently in different types of funds, which is explained below.

Equity Mutual Fund – Equity-oriented mutual: These funds invest at least 65% of their portfolio in equity assets. If you hold the units of these schemes for less than one year, then the profit earned will fall in the category of short term capital gain, which is taxed at the rate of 10%. On the other hand, investment profits of more than 1 year come under the category of long term capital, on which tax rate of 15% is applicable. It is important to note here that if the amount of capital gain is less than Rs 1 lakh then it is completely free from tax.

Debt Mutual Fund – Debt-oriented mutual funds: These funds mainly invest in debt instruments like government securities, fixed income schemes and bonds etc. If you hold the investment of these funds for less than 3 years or 36 months, then it comes under the category of short term capital gain which is taxable as per your income tax slab. If the fund is held for more than 3 years then it will fall in the category of long term capital gain on which *Indexation – After indexation, 20% tax rate is applicable.

Hybrid mutual funds – Hybrid mutual funds: These funds invest in a mix of debt and equity securities. The tax applicable on these depends on the allocation of equity and debt and the holding period.

Different long term and short term taxes are levied on different funds as per the table given below:

Fund Type	Short term capital Gain	Long term capital Gain	Short term capital Gain%	Long term capital Gain%
Equity	less than 1 year	More Than 1	15%	10%
Debt	less than 3	More Than 3	As per investor’s tax slab	20%
Hybrid Equity Fund	less than 1	More Than 1	15%	10%
Hybrid Debt Fund	less than 3	More Than 3	As per investor’s tax slab	20%

Dividend income tax

Before April 1, 2020, whatever dividend was declared by the fund house, Dividend Distribution Tax (DDT) was paid before distributing it to the investors, hence investors did not have to pay any tax on mutual fund dividend income. But after the Union Budget of 2020, this rule was changed and all the dividends received by investors started being included in the tax net under “income from other”. Apart from this, if the dividend paid by the fund house crosses the limit of Rs 5000 in a financial year, then the AMC has to deduct flat 10% TDS on it. However, you can claim this TDS when you file tax returns.
ELSS Schemes

ELSS means Equity Linked Saving scheme. This scheme is mainly designed for the purpose of tax saving, on which profits up to Rs 150,000 can be availed of tax rebate under section 80c.

Tax on SIP

SIP is a disciplined and periodic way of investing in mutual funds in which small amounts can be invested over a fixed period, such as one month, three or six months. Every time you invest through SIP, some units are deposited in your portfolio according to the investment amount. The investment made in SIP and the redemption taken are calculated on first in first out basis.

Based on this concept, tax is also applicable on SIP investment. That is, for equity investment, all the units which are in your portfolio for less than one year will come under short term and all the units which have been held for more than one year will come under the purview of long term capital gain. Similarly, for debt funds, units of less than 3 years come under short term capital gain and units of more than 3 years come under long term capital gain. For example, you have invested in a scheme for 2 years. At the time of redemption, the units which are under 1 year (investment made within 12 months) will be short term and the units which are after 1 year will be in the category of long term capital gains (investment after 12 months). However, if the total capital gain amount is less than Rs 1 lakh then you will not have to pay any tax on it. It is important to note here that short term capital gain is applicable only on investment units purchased from the second month onwards. While paying capital gains tax, you also have to pay the cess and surcharge applicable on it.

Tax on SWP

It can be said that in SWP only money is transferred from one scheme to another but this process is much more than that. Under SWP, the money is first redeemed from the scheme from which the units are to be transferred, which is considered as selling the units of the fund. Similarly, in the scheme in which money is transferred, it is considered as purchasing the unit. Now this entire process involves buying and selling of mutual fund units, hence it comes under the tax net like normal situation. Whereas in SIP you can invest a fixed amount in a mutual fund at a fixed time, similarly in SWP you can withdraw a fixed amount at a fixed time. In this, the investor has the freedom to choose whether he wants to withdraw a fixed amount or only a part of the capital gains. If investment is withdrawn from equity fund before 1 year then it comes in the category of short term capital gain and if it is more than 1 year then it comes in the category of long term capital gain. The rate of short term capital gain is 15% while long term capital gain is taxed at 10% without indexation. In case of debt scheme, if redemption is taken before 36 months, then the profit is added to your total income and tax is applicable as per the prevailing income tax slab. After indexation, 20% tax is applicable on capital gains after 36 months.

State Transaction Tax

STT is collected by the Government of India, which was first introduced in the Union Budget of 2004 and implemented on 1 October 2004. STT or State Transaction Tax is different from the tax on capital gains and dividends. The Government of India collects this tax when you sell your mutual fund units from equity or hybrid funds. Its fund is separate from its mutual fund and this tax is not applicable on debt mutual funds. Its rates on equity related mutual funds are shown in the table below.

Security Type	Transaction Type	STT Rate	STT  Levied On
Equity Mutual Funds	Buy	Nill	Nill
Equity Mutual Funds- Close Ended/ ETF	Sell	0.001%	Seller
Equity Mutual Funds- Open Ended	Sell	0.025%	Seller
Equity Mutual Funds-Intraday (Non-Delivery)	Sell	0.025%	Seller

Indexation benefit

If we are talking about tax then it becomes necessary to clear the indexation benefit also. Through indexation benefit, capital gains on mutual funds are compared with inflation, thereby reducing the overall tax liability. Whenever an investor sells his mutual fund units, the capital gain is taxable. Under indexation benefit, an investor can adjust his investment profits as per the ongoing inflation rate. Such adjustments reveal the actual value of capital gains on investments. That is, the price which is obtained by subtracting the ongoing inflation rate. To calculate this price, a standard is used which is called Cost of Inflation Index (CII). This standard is revised by the Finance Ministry every year at the time of budget and it can be easily seen on the Income Tax website.

Indexation benefit is applicable only in case of long term capital gains on debt mutual funds. For example, an investor bought 5000 units of a debt mutual fund in 2012-13 at Rs 18 and sold it at Rs 27 in 2018-19. Now this time is more than 36 months, so the profit made here will come in the category of long term capital gain.

Total profit made in this: 5000 (27-18) = Rs 45000

Net value after adjusting for inflation: (280/200)*18 =25.2

Here the Cost Inflation Index number is 280 for 2012-13 and 200 for 2018-19 and 18 is the price at which the units were purchased.

Thus, the long term capital gain on this after indexation will be:
5000 x (INR 27- INR 25.2) = INR 9000

Now whatever tax the investor has to pay will have to be paid on the capital gain of Rs 9000 and not on the capital gain of Rs 45000.

Conclusion

The government raises money for the economy and national interest of any country only through taxes. For a common citizen who files his ITR every year, it becomes necessary to declare the income earned from mutual funds. According to your convenience and tax planning, you can keep it in the category of long term or short term tax. Even if your income does not come under the ambit of tax, still declare it, whatever refund is made, you can claim it later. There are many such provisions in Income Tax, through which you can avail tax rebate on your investment profits under different sections. If you use the right information and professional advice, then these small savings will give rise to big savings in the future.