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Understanding mutual fund taxation in India is crucial for investors to make informed financial decisions. The tax implications associated with mutual funds can significantly impact the returns on investments. From capital gains tax to dividend distribution tax, there are various taxation aspects that investors need to consider. In this guide, we will delve into the intricacies of mutual fund taxation in India. By gaining a comprehensive understanding of mutual fund taxation, investors can effectively plan their investment portfolios and maximise their after-tax returns.
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Understanding Mutual Fund Taxation In India
If one already holds mutual funds or intends to in the future, it is important to know what taxes will be paid on one’s mutual fund’s returns. Mutual fund profits and gains are taxed at the same rate as most asset classes in which one holds the investments.
By learning more about the tax of mutual funds, one can prepare investments that will reduce one’s total tax burden. One may also be able to benefit from tax exemptions in certain circumstances. Therefore, one should receive information on the taxation of mutual fund regulations at the time of investment.
Factors Determining Tax on Mutual Funds
- Type of Mutual Fund: Two kinds of mutual funds are subject to taxation. These are mutual funds that focus on debt and equity.
- Dividends: A portion of the profit distributed to investors by mutual fund companies is called a dividend.
- Capital Gains: A profit is a capital gain when an investor disposes of his equity assets at a more favourable price than the overall investment amount.
- Holding Period: From the date on which a fund unit is bought and sold. According to the Income Tax Act, one will be liable to pay a lower tax rate if one holds investments for an extended period. Therefore, the tax rate payable on capital gains is affected by the period in which one’s shares are held. One is liable to pay less tax if the holding period is longer.
Profit Generation Possibility
While it does not come with a guarantee, mutual funds offer investors the opportunity to receive either capital gains or dividends. Let’s take a closer look at them and see how they differ.
- Capital gains on mutual funds are realised when the units are redeemed, not when they are purchased.
- Capital gains tax on mutual funds is payable at the time of redemption and is calculated based on the profit made from selling the units.
- Dividends received from mutual funds are another way investors receive profits from their investments.
- Dividends distributed by mutual funds are subject to taxation and are added to the investor’s taxable income.
- The taxation of mutual fund dividends follows the classical method, where dividends are taxed at the investor’s applicable income tax rate.
- Previously, dividends from mutual funds were tax-free, but this changed with the amendments made in the Union Budget 2020.
- Mutual fund capital gains are taxed based on factors such as the holding period and the type of mutual fund, with different tax rates applied accordingly.
Mutual Fund Capital Gain Taxation
Mutual fund short term and long term capital gains are taxed at different rates.
Capital Gains Tax on Equity Funds
Mutual funds that invest over 65% of their overall fund in the company’s stock are known as equity funds. As mentioned above, one can realise short term capital gains if one redeems equity fund units within one year. These gains are taxed at a flat rate of 15%, regardless of one’s income tax bracket.
Debt Fund Capital Gains Tax
Debt funds are those with a portfolio debt exposure above 65% or equity exposures below 35%. Debt funds shall no longer be eligible for indexation benefits and are considered to have a shor term capital gain as of 1 April 2023. Accordingly, debt fund gains will be added to one’s income tax and taxed at a marginal rate.
Taxation of Capital Gains in Hybrid Funds
The amount of equity exposure the portfolio has determines how much tax must be paid on capital gains from hybrid or balanced funds. The fund scheme is taxed similarly to an equity fund if the equity exposure reaches 65%, otherwise, the taxation regulations for debt funds are in effect. It is, therefore, important to know the equity exposure of the hybrid scheme one invests in. If not, it will give rise to an unpleasant surprise when one’s fund units are redeemed.
SIP (Systematic Investment Plan) Capital Gains Taxation
In this situation, the units bought through a SIP are maintained for at least one year, showing longer term capital gains. One does not need to pay taxes if the long term capital gain is less than ₹1,00,000. One makes short term capital gains from the second month on by purchasing units bought with SIPs. No matter the income tax classification, these gains are taxed at a flat rate of 15%. The applicable duty and levy shall be charged to one.
Conclusion
If investors are concerned that their returns from mutual funds will be reduced once they have paid taxes, they can learn how mutual funds are taxed. By calculating how the tax rules for long and short term investments in equity or debt funds vary, they can figure out which ones are beneficial to them. Investing in tax-saver funds can decrease their tax liabilities and capital creation. Both lump sum and SIP purchases of a certain type of fund are subject to the same taxation. However, holding units for a short time may be more tax advantageous than investing for a long time. If one is willing to invest in mutual funds, utilise the Share India trading platform for a suitable investment plan and a simple user experience.