How mutual funds are taxed?
Saving taxes are a top priority for investors when it comes to investing in mutual funds. There are many types of mutual funds that are available in the market. With the type of mutual fund the taxation for the mutual fund also varies. There are other factors like holding period which influence the taxation.
In the this article of about how mutual funds are taxed we will touch on all elements of mutual funds which influence their taxation.
Types of mutual fund holding periods
Holding period for your mutual fund investment (How long ago you purchased the mutual fund) are of 2 types
1. Long-Term Holding Period
In the case of equity mutual funds, a holding period of 12 months or more is regarded as ‘long term’.
For debt funds, a holding period of 36 months or more is regarded as ‘long term’.
2. Short-Term Holding Period
Equity investments are considered ‘short term’ if the holding period is less than 12 months. Debt funds held for less than 36 months are regarded as short term.
The following table gives a glimpse of the holding period classification of mutual funds:
|Equity funds||Less than 12 months||12 months and more|
|Balanced funds (equity-oriented)||Less than 12 months||12 months and more|
|Balanced funds (debt-oriented)||Less than 36 months||36 months and more|
|Debt funds||Less than 36 months||36 months or more|
Hybrid equity-oriented funds (equity exposure of more than 65%) are considered as equity funds for taxation. If the equity exposure in a hybrid fund is less than 65% or is equally exposed to equity and debt instruments, i.e. 50% equity and 50% debt, then it is considered as a debt fund for taxation.
Taxation on Mutual Funds
1. Equity Funds
- Short term capital gains(STCG) – If any stock or equity-oriented mutual fund (more than 65% equity portfolio) is sold before 12 months of purchase, 15% tax would be applicable on the gains.
- Long term capital gains(LTCG) – If any stock or equity-oriented mutual fund (more than 65% equity portfolio) is sold after 12 months of purchase then gains up to Rs 100,000 are exempt from Income tax. All gains above this limit are taxed at 10%.
2. Debt Funds
- Short term capital gains(STCG) – If any debt instrument or debt-oriented mutual fund is sold before 36 months of purchase, the returns or short-term capital gains are added to your income and taxed according the income tax slab (0%, 5%, 20% or 30%). applicable to the investor.
- Long term capital gains(LTCG) – If held for more than 36 months, all gains are treated as long-term capital gains and taxed at 20% with indexation benefit. Indexation help you to inflate your purchase cost with cost of inflation index and bring down your tax liability.
If you are planning to sell your debt mutual fund then you tax slab matter a lot. If you in 30% bracket and sell you debt mutual fund with in 3 years then you end up paying a lot of taxes on your profit!
3. Balanced Funds
Balanced funds are taxable depending on their equity exposure. Hybrid equity-oriented funds are taxed as any other equity fund while hybrid debt-oriented funds are taxed as any other debt fund.
Often people get confused about how SIP in mutual funds are taxed?
For instance, you initiate an SIP of Rs 10,000 a month in an equity fund for 12 months. Each SIP is considered to be new investment. Hence, after 12 months, if you decide to redeem your entire accumulated corpus (investments plus gains), all your gains will not be tax-free.
Only the gains earned on the first SIP would be treated for Long term capital gains(LTCG) tax because only that investment would have completed one year. The rest of the gains would be subject to Short term capital gains(STCG) tax.
5. Securities Transaction Tax (STT)
Apart from these, there is another type of tax called the Securities Transaction Tax (STT). An STT of 0.001% is levied by the government (Ministry of Finance) when you decide to sell your units of an equity fund or a hybrid equity-oriented fund. There is no STT on the sale of debt fund units.
How mutual funds are taxed? – closing thoughts!
It imperative to understand the taxation on mutual funds so that you can most money out of your mutual funds. At the same time you shouldn’t invest in mutual funds only to save taxes. Have a clear vision of why you are investing in a mutual fund and is it giving you the value as you have expected.
We hope by now you have understood how mutual funds are taxed, Consider reading How to select mutual funds India? which will help you how you should select your next mutual fund for investments.
How to calculate tax on sip in mutual funds?
Taxes on SIP returns are done on pro-rata basis i.e. When you invest your money in a SIP then the data of the SIP transaction is taken for tax purpose for the amount of units allocated for the money you have invested.
Are mutual fund returns taxable?
Yes. mutual fund returns are taxable as per the fund type. Equity and debt mutual funds are taxed differently as per the holding period. Debt funds have an option having indexation benefits which equity mutual funds do not have!
Are ELSS returns tax free?
No. Returns from ELSS funds will be eligible for long term capital gains tax since they have a lock-in period of 3 years. How ever investors do not need to pay any tax if your gains from mutual funds are under 1 lakh rupees. If you have gains over 1 lakh rupees for the financial from mutual fund the you need to pay long term capital gains tax.