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How Are Mutual Funds Taxed in India?

It is that time of the year when everyone is thinking of investment proof and tax benefits. You can save taxes by investing in specific mutual funds, but what about mutual funds tax components? Are all mutual funds taxed equally? Let’s explore the taxation aspect of mutual funds in this article.

Mutual fund returns are from dividends and capital appreciation. Dividends from equity-oriented funds, including the Equity Linked Savings Scheme (ELSS), attract Dividend Distribution Tax of 10% but is tax-free for investors. Capital gains are taxable depending on the holding period and the type of fund.

Holding Period

The duration of time an investor stays invested is said to be the holding period. It is significant in determining whether the capital gains are long term or short term. Accordingly, the rate of tax will change for equity and debt-oriented mutual funds.

The holding period for different types of funds is explained in Table 1 below:

Type of Funds

Long Term

Short term

Equity-oriented funds

12 months or more

Up to 12 months

Debt-oriented funds

36 months or more

Up to 36 months

Table 1

Mutual funds are classified into Equity, Debt and Hybrid equity funds.

Equity-oriented funds are linked to investment in equity.

Debt-oriented funds invest in fixed income securities and are relatively unaffected by market volatility.

Hybrid equity funds invest 65:35 in equity and debt.

Rate of Capital Gain Tax

The rate of Long-Term Capital Gains (LTCG) and Short-Term Capital Gains (STCG) tax for different mutual fund types are explained below in Table 2:

Type of Funds

LTCG Tax

STCG Tax

Equity-oriented funds

10% if the capital gains exceed INR 1 lakh

15%

Debt-oriented funds

20% with indexation benefit

Taxed according to the income tax slab

Table 2

SIP investments are taxed separately for each transaction.

Indexation is a benefit available to long-term investment that reduces tax liability. It is available for debt-oriented mutual funds invested for 36 months or more.

Securities Transaction Tax (STT)

Sale of equity and hybrid equity-oriented funds attract an STT of 0.001% and capital gains tax.

There is no STT on the sale of debt fund units.

Equity Linked Saving Scheme

It is a market-linked investment instrument. The minimum investment is INR 5,000 for lump sum investments and INR 500 for Systematic Investment Plan (SIP).

ELSS generates dividends and long term capital gains. Its dividends are tax-free for the investor. Capital gains are taxable at 10% and INR 1 lakh per year is exempt.

Advantages:

  • It is eligible for a deduction under section 80C for a maximum of INR 1,50,000

  • Provides lock-in period of three years; it is the shortest among other tax saving investment options

  • Offers SIP option

  • Gives returns range between 15% to 18% which is higher than other tax-saving instruments

Thus, mutual funds save your tax bill in the long-run. It is beneficial if you stay invested for a longer period to receive higher returns and tax benefits.

Happy Investing!

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