Mutual Fund Taxation explained based on Mutual Fund Types

The most important rule of mutual funds investments is to leave the rough calculation procedures in a coffin before calculating the returns. More often than not, investors fail to keep the rules of tax on mutual fund in mind. This is because there was a time when there were several tax exemptions on LTCG (Long Term Capital Gains) on equity mutual funds. It is no wonder that taxation on mutual funds can get a little confusing for those who are not familiar with the funds’ investments. 

The government of India made major changes to the dividend tax rules on mutual funds which came into action from 1st April 2020. As per this rule, dividends will be taxed at the hands of investors as per their defined tax slabs. Moreover, the investors will have to add their dividend income with the total income as no special categorisation is available for dividends as per the new tax in India policy. 

Calculations of tax on mutual fund can be troublesome if one does not have a clear idea. 

Taxation Rule For Capital Gains 

The calculation of capital gains tax on mutual fund is very easy and simple. The first thing to note is that this tax is only applicable when an investor sells his mutual funds. Now, the taxable amount is calculated by deducting the principle amount from the total value of the fund at the time of sale. In short, the profit earned from selling mutual funds is taxed by the government. 

For instance, investor A makes a mutual fund investment of INR 1000 for 1 year at an interest rate of 12%. At the end of his tenure, if he sells his fund, the total value of it will be 1120 (1000 + 120). So, this additional sum of 120 that he has gained from his investment is the taxable amount. Depending upon the type and tenure, the tax on mutual fund is classified into two categories. 

LTCG (Long Term Capital Gains)

Any investment that surpasses the mark of 12 months is classified under the Long Term Capital Gains (LTCG). Investors enjoy more privilege and favourable tax treatment under this category. This can be divided into two broad sections: 

Tax Saving Mutual Funds 

The Equity Linked Saving Schemes (ELSS) come under this category and are eligible for tax exemption under the Section 80C of the government of India. The maximum amount exempted under this law in INR 1.5 lakhs. Apart from this major fund, LICs school fees of children and PFs (Provident Funds) also qualify. 

An investor has two options:

  • He can invest 1.5 lakhs in ELSS funds to claim the entire tax exemption. 
  • Alternatively, if he shows PFs or school fees as 80,000 then he will be eligible only for 70,000 investment in ELSS. 

Non-Tax Saving Mutual Funds 

In the case of Large-cap, Mid-cap and Small-cap funds, the applicable tax on the investment is 10% if the amount exceeds 1 lakh. Investors should take the help of professionals who have an idea about tax on mutual fund to get a clear picture of the total taxable amount. 

STCG (Short Term Capital Gains)

The short term capital gains on an investment are taxed at an interest rate of 15%. 

Debt Funds

For debt funds, the short term capital gains are added to the income slab of the investor and then taxed accordingly. The percentage may vary between 5, 20, or 30, etc. This is applicable only for mutual funds that are sold within 3 years of purchase. For any tenure above that, the taxation is levied as per long term capital gains. Under the LTCG taxation, the investor has to pay 20% tax on the mutual fund. 

Hybrid or Balanced Funds 

Hybrid funds are usually categorised as equity-oriented funds for which the tax rules of “non-tax savings equity funds” are implemented on these. Investors must know that a balanced fund makes investments in almost every form of equity, bonds and securities. 

SIPs (Systematic Investment Plans)

The SIPs are the most sought after mutual funds plans as it suits the needs of almost all types of investors. High-risk appetite investors choose the long term SIPs while the low-risk ones prefer short-term plans. The taxation of SIPs is also variable as the capital gains are calculated considering the loan period which varies from one investment to another. 

Tax On Income From Dividends 

As mentioned earlier, the old tax on mutual fund for dividend income has been scrapped recently by the finance minister of India. As per the new rules, dividend income will be added to the total annual income of the investor and taxed accordingly. 

There are plenty of occasions when investors get confused with the tax on mutual fund and how it may affect their returns from the investment. Although there are many experts willing to provide paid services for simplifying these concepts, it is always better to have some basic idea. After all, an intelligent investor should always know the minor detailing.