Mutual Funds Taxation

Understanding mutual fund taxation or tax on mutual funds is a must for every investor. It provides clarity about how income from investing in mutual funds is taxed. Mutual funds are one of the most popular investment tools amongst investors. Learning about tax on mutual funds is a smart way to reduce your over-tax burden. Read on to learn more about mutual funds taxation in detail.

Factors to determine the tax on mutual funds

Tax on mutual funds can be easily understandable when bifurcated into different categories. Below are a few of the factors to determine the tax on mutual funds:

• Type of funds
  Depending on the type of mutual funds are taxed accordingly, such as Debt Mutual Funds, Hybrid Mutual Fund, Equity-Oriented Mutual Funds, Debt-Oriented Mutual Funds, etc.
• Dividend
• A dividend is a part of the profit that is distributed amongst the investors by the mutual fund house. As an investor, you don’t have to sell any assets to receive a dividend.
• Capital Gains
  Capital Gain is considered when a capital asset is sold at a higher price than its purchased price at a profit.  
• Holding period
  The time period an investor holds their mutual funds is considered as holding period. This influences the tax rate on capital gains – lower tax rates are applicable if the holding period is longer. 

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Taxation on dividends

Earlier, the investors were exempted from any taxation on dividends as the companies were levied with dividend distribution tax (DDT). With the amendments made in the Union Budget 2020, dividends received by any investor are taxed at their respective income tax slab rates.

• For investors, it should be added as his total income under the head income from other sources.
• For salaried individuals, it should be disclosed under ‘Income from other sources” in ITR-1.

Taxation on mutual funds capital gains

The holding period of mutual funds decides the tax rate applicable to capital gains for mutual funds. The holding period is when the investors hold the units of mutual funds. The holding period is usually measured between the date of mutual funds buying and selling of mutual funds.

Pre-Budget 2024

Post-Budget 2024

Below are a few of the assumptions made due to a few vague aspects:

• *A 12.5% tax is applicable if investments are made before April 1, 2023, and sold after two years.
• **Stating from April 1, 2025, if withdrawals are made before it will be taxed at your slab rate.

Taxation on Equity funds capital gains

If more than 65% is invested in equity, it is classified under equity funds. Depending on the holding period, it can be taxed as short-term capital gains or long-term capital gains. If you redeem your equity funds within one year of the holding period, it is termed as short-term capital gains. If you hold your equity funds for more than one year and redeem them, it will be categorized under long-term capital gain. These capital gains are tax-free up to ₹1.25 Lakh per year and any long-term capital gain above ₹1.25 Lakh is taxed at 12.5%, with no indexation benefits.

Taxation on Debt funds capital gains

Previously, the long-term capital gains from debt funds were taxed at 20% with indexation benefits. Starting from April 1, 2023, the debt funds will not receive any indexation benefits and will be categorized as short-term capital gain. The gains will be added to your total taxable income and will be taxed as per your regular income tax rate.

Please note: Debt funds are mutual funds that invest over 65% in debt and less than 35% in equity.

Taxation on hybrid funds capital gains

The equity exposure of hybrid or balanced funds depicts the tax rate on capital gains. It is taxed as an equity fund if a hybrid fund has over 65% in equity. On the other hand, if the equity is less than 65%, it is taxed as debt funds.

Securities Transaction Tax or STT

Securities Transaction Tax (SST) applies when you buy or sell mutual fund units of equity funds or hybrid equity-oriented funds and is usually 0.001% of the transaction value. However, there is no SST when you sell debt funds units.

How to calculate tax on mutual fund redemption?

Below are a few of the steps to calculate tax on mutual fund redemption:

• Step 1: Identify the Type of Fund and Holding Period
• Step 2: Calculate the Gains
• Step 3: Apply the Relevant Tax Rate

Formula: Capital Gain = Redemption Price – Purchase Price

Please note: Refer to the above table for applicable tax rates and calculations.

Conclusion
Understanding tax on mutual funds is helpful if you are considering investing in mutual funds and worried about mutual fund taxation, especially after the new amendments in taxation. Depending on the holding period and type of equity, the taxation is calculated. If you hold your mutual funds for long, you can enjoy more tax benefits as compared to the short term.