by Team Sharekhan
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Unlike fixed deposits, which can be tax-inefficient for those in higher tax brackets, mutual funds present a more favourable tax scenario. This article covers the intricacies of mutual fund taxation, ensuring you're well-equipped to make informed investment decisions.
Budget 2023 brought significant changes affecting mutual fund investors. Notably, the absence of indexation benefits for long-term capital gains on specified mutual funds, defined as those investing less than 35% in domestic company equities, alters the landscape. Debt mutual funds, as a result, will now adhere to the applicable slab rates for taxation.
The tax on mutual funds in India is akin to a financial handshake between your investments and the government. When your mutual funds yield profits, the taxman takes a portion, with the rate depending on factors like the type of fund and how long you've held it.
Several key factors influence mutual fund taxation:
1. Fund Types: The type of mutual fund (e.g., Equity Mutual Fund, Debt Mutual Fund, Hybrid Mutual Fund) dictates the taxation rules.
2. Dividend: Mutual fund houses distribute some profits as dividends to investors.
3. Capital Gains: Profits from selling mutual fund units at a higher price than the investment cost.
4. Holding Period: The duration between buying and selling mutual fund units impacts the tax rate, with longer holding periods benefitting from lower taxes.
Mutual funds offer returns in two main forms: dividends and capital gains. While dividends represent a share of the fund's profits distributed among investors, capital gains arise from the appreciation in the price of mutual fund units. Both are taxable to investors.
Pro Tip: Investing in direct mutual funds can significantly reduce commission costs, potentially boosting returns by up to 1.5%.
After the Union Budget 2020 amendments, dividends from mutual funds tax are added to the taxable income according to the investor's income tax slab. This marked a shift from the previous approach, where dividends were exempt in the hands of investors due to the Dividend Distribution Tax (DDT) paid by companies.
Capital gains taxation in mutual funds varies based on the holding period and the type of fund:
1. Equity Funds: Less than 12 months (Short-term) | 12 months and longer (Long-term)
2. Debt Funds: Always considered short-term
3. Hybrid Equity-Oriented Funds: Same as equity funds
4.Hybrid Debt-Oriented Funds: Always considered short-term
The short-term and long-term capital gains rates differ, providing an incentive for longer-term investments.
The tax rates for mutual funds before and after March 31, 2023, vary significantly:
Fund Type | Holding Period | STCG | LTCG |
Equity Mutual Funds, Arbitrage Funds, and Other Funds (=65% in equity) | 12 months | 15% | 10% without indexation |
Debt Mutual Fund, Floater Funds | 36 months | Slab rate | Slab rate (post-Mar 2023) |
Conservative Hybrid Funds, Other funds (=35% in equity) | 36 months | Slab rate | Slab rate |
Other funds (>35% but <65% in equity) | 36 months | Slab rate | 20% with indexation |
Balanced Hybrid Funds | 36 months | Slab rate | 20% with indexation |
Aggressive Hybrid Funds | 12 months | 15% | 10% without indexation |
Systematic Investment Plans (SIPs) offer a flexible way to invest in mutual funds, with the tax on gains depending on each SIP instalment's holding period. Long-term capital gains from units held for over one year are taxed more favourably than short-term gains.
STT, assessed at 0.001% on the buy/sell of equity or hybrid equity-oriented mutual fund units, adds another layer to mutual fund taxation, emphasising the tax-efficient nature of mutual fund investments.
The strategic advantage of mutual funds lies in their tax efficiency, particularly for long-term investments. Understanding the complexities of mutual fund taxation, including recent changes and different rates for capital gains, is essential for maximising your investment returns while minimising tax liabilities. By staying informed and making strategic choices, investors can confidently navigate the tax landscape of mutual funds in India.
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