Tax on Mutual Funds

Mutual funds are popular among Indian investors due to their high returns and wealth diversification. However, understanding their taxation is crucial to maximising profits and complying with tax laws. In this blog, we’ll explore how mutual funds are taxed in India, explaining it step-by-step so it’s easy to grasp.

Taxation on Mutual Funds

Mutual fund investments are subject to various tax regulations in India. The taxation rules can significantly impact your overall returns. Therefore, it’s essential to be well-versed with the tax implications associated with mutual funds.

Variables Determining the Taxation for Mutual Funds

Several factors influence how mutual funds are taxed in India. Let’s explore these variables in detail:

How Do Mutual Funds Generate Profits?

Mutual funds generate profits through:

Capital Appreciation: Increase in the value of the fund’s assets.

Dividends: Distribution of a portion of the earnings to investors.

Interest Income: Earned from investments in bonds and other fixed-income securities.

Taxation of Dividends Provided by Mutual Funds

Previously, dividends from mutual funds were tax-free in the hands of investors as the fund house paid a Dividend Distribution Tax (DDT). However, from April 1, 2020, dividends are taxed according to the investor’s applicable tax slab rate.

Taxation of Capital Gains Provided by Mutual Funds

The taxation of capital gains from mutual funds in India depends on various factors such as the type of mutual fund (equity-oriented or debt-oriented), the holding period of the investment, and the nature of the gains (short-term or long-term). Here’s a detailed overview:

Taxation of Capital Gains of Equity Funds

Short-Term Capital Gains (STCG): Taxed at 15%.

Long-Term Capital Gains (LTCG): Gains exceeding ₹1 lakh in a financial year are taxed at 10% without indexation.

Taxation of Capital Gains of Debt Funds

Short-Term Capital Gains (STCG): Added to the investor’s income and taxed as per the applicable income tax slab.

Long-Term Capital Gains (LTCG): Taxed at 20% with indexation benefits.

Taxation of Capital Gains of Hybrid Fund

The Taxation on Hybrid funds is based on their equity exposure:

Equity-Oriented Hybrid Funds: Taxation similar to equity funds.

Debt-Oriented Hybrid Funds: Taxation identical to debt funds.

Taxation of Capital Gains When Invested Through SIPs

Systematic Investment Plans (SIPs) are taxed on a First-in, First-out (FIFO) basis. Each instalment is treated as a separate SIP investment and taxed accordingly based on the holding period.

Securities Transaction Tax (STT)

Securities Transaction Tax (STT) is a tax the Indian government charges on buying and selling securities on recognised stock exchanges. For mutual funds in India, investors don’t pay STT directly when buying or selling mutual fund units. Here’s how it usually works:

Equity-oriented Mutual Funds:

For equity-oriented mutual funds, STT is not directly applicable to investors. However, the mutual fund pays STT on the equity shares it buys or sells as part of its portfolio management. This cost is borne by the mutual fund and indirectly affects its overall returns.

Debt-oriented Mutual Funds:

Debt-oriented mutual funds primarily invest in debt instruments such as government securities, corporate bonds, etc. STT does not apply to these transactions because STT is aimed mainly at equity transactions on stock exchanges.

Exchange-Traded Funds (ETFs):

ETFs are like mutual funds but traded on stock exchanges like individual stocks. Since they are traded on exchanges, STT is applicable on the purchase and sale of ETF units on these exchanges, similar to stocks.

While STT does not directly impact investors in most mutual fund transactions (except ETFs), it is an essential consideration for mutual fund companies managing equity-oriented funds, as it affects their operational costs and potentially the overall returns they can provide to investors. Always consult a financial advisor or tax consultant for advice tailored to your investment situation.

Conclusion

Understanding how mutual funds are taxed in India is essential for getting the most out of your investments and following tax rules. The tax rules for equity, debt, and hybrid funds depend on how long you hold the investment and the type of gains you earn. Short-term gains and long-term gains are taxed at different rates. Knowing these details can help you maximise your returns and adhere to tax laws.

Additionally, dividends from mutual funds have been taxed at the investor’s applicable slab rate since April 1, 2020. While Securities Transaction Tax (STT) indirectly impacts mutual fund operations, investors should stay informed and seek guidance from financial experts to optimise their investment strategies and minimise tax liabilities effectively.