The asset under management of the mutual fund industry in India stood at 38.01 Lakh crores as of Jan’2022. As the industry saw a growth of 2x in the last five years, many new market participants are eager to invest in the category.
One feature that makes mutual funds attractive is the tax efficiency of returns. Before we can understand how returns are taxed, let us glance through the types of returns you can earn while investing in mutual funds.
Types of Mutual Fund Returns
As a shareholder, you receive dividend distributions as part of your share of stock earnings. It can be viewed as a reward from the company for investing in its equity.
You invest in stocks in the present with the intention of selling them for a profit later. Gains on the sale of stock are known as capital gains, and they are realized at the point of sale. Capital gains in India are taxed according to your period of holding.
Now that both income streams are defined let us look at how income is taxed on mutual funds.
Taxation for Mutual Funds
Taxation of dividends:
As per the current tax regime, dividends from mutual funds are taxed as per the applicable slab rates. The company or mutual fund will withhold tax @10% for dividend income exceeding Rs. 5,000.
Taxation of capital gains:
As stated earlier, the taxation of capital gains depends on the period of holding of your assets.
For an equity-oriented mutual fund, units held for less than 12 months are subject to short-term capital gains, and units held for greater than equal to 12 months are subject to long-term capital gains.
Similarly, for a non-equity-oriented mutual fund, units held for less than 36 months are subject to short-term capital gains, and units held for greater than equal to 36 months are subject to long-term capital gains.
Equity Oriented Mutual Funds:
Short-term capital gains tax on mutual fund income is charged at 15% as per Sec 111A of the Income Tax Act.
Long-term capital gains tax on mutual fund income is charged at 10% over and above Rs 1 lakh as per Sec 112A of the Income Tax Act. You should note that no indexation benefit will be available for such gains.
Non-Equity Oriented Mutual Funds:
Short-term capital gains are charged at slab rates applicable as per the Income Tax Act.
Long-term capital gains are charged at 20% as per Sec 112 of the Income Tax Act. You should note that indexation benefits will be available for such gains.
The above tax treatment was for investors investing at once in mutual funds. However, for investors opting for a Systematic Investment Plan, the capital gains are charged in a different manner.
Systematic Investment Plan (SIP)
The taxation of SIP plans differs with respect to units purchased and settled. In a SIP, units are sold on a FIFO basis. Thus, if you purchase 100 units today and sell them after a year, you would attract long-term capital gains. However, if you sell them before a period of 12 months, you would attract short-term capital gains.
The rates for capital gains remain the same at,
Short-term capital gains are charged at 15% as per Sec 111A of the Income Tax Act.
Long-term capital gains are charged at 10% plus applicable surcharge over and above Rs 1 lakh as per Sec 112A of the Income Tax Act. You should note that no indexation benefit will be available for such gains.
Securities Transaction Tax (STT)
Securities Transaction Tax (STT) is another mutual fund tax in addition to dividends and capital gains taxes.
The Ministry of Finance imposes a securities sales tax of 0.001% on the purchase or sale of mutual fund units of equity funds or hybrid equity funds. The sale of debt fund units is not subject to STT.
Mutual funds offer the benefits of smaller investments, higher returns, and tax efficiency. Choose your asset life correctly to incur lesser capital gains tax.