How Mutual Fund Investments Are Taxed

Retail investors who procrastinate in filing their income tax returns (ITRs) till the last week of July have found another reason to delay filing their ITR. The Central Board of Direct Taxes (CBDT) has extended the due date for filing IT returns from July 31 to August 31 for the assessment year 2018-19. Individuals and entities whose accounts are not required to be audited need to file their IT returns by August 31, 2018 for AY 2018-19, without attracting any penalties. The mutual fund investor need to be extra cautious this year before filing their income tax return. The reason being the Government of India in its Union budget of FY19 re-introduced long term capital gains (LTCG)tax and dividend distribution tax (DDT) on mutual funds. The LTCG made till January 31, 2018 remains grandfathered, which means any gain made till that date will remain tax exempt. Nevertheless, any transaction made between February 1 and March 31, 2018 will come under the purview of new tax system if they meet the holding period criterion and accordingly tax is chargeable.

Determining the holding period 

Mutual fund investments are capital assets and they are taxed primary based on the type of fund and the period for which the investment is held. Mutual fund schemes at broader level are classified based on instruments in which they are investing. If a fund has invested more than 65% of its corpus in equities, it will be classified as equity-oriented fund. The reason for such classification is the duration of holding period for different types of funds is defined differently for tax purposes. In case of equity funds, holding period of less than one year is construed as short term holding, while for debt-oriented funds any investment held for less than three years is termed as short term holding. Equity funds held for more than one year will be taxed at a rate applicable for long term capital gains. 

Calculating tax 

Tax is applicable on the gain(loss) you made on selling your investments, which is the difference between your buying price and current market value of your investments. Different tax rates are applicable for different period of holding.

Equity Funds 

In case of equity-dedicated mutual funds, long-term capital gains will be taxed at the rate of 10 per cent without indexation benefit. When you sell your equity fund before one year, short term capital gain (STCG) tax will be applicable to you, which is currently 15%. In the case of lumpsum investment, there is no problem in calculating your tax burden, however, the complication arises when you have opted for investment through systematic investment plan (SIP), which seems to be the preferred route of MF investment now.

The basic rule that applies while calculating capital gains for investment done through SIP is FIFO, which means ‘first in, first out'. This method assumes that the units bought first were sold first and so on. Let us assume that you started your investment on January 1, 2017, and continued till August 1, 2018, and accumulated 6942 units during this period (See table below). 

So, if you are now selling your mutual fund units in the month of July 2018, you will have to pay long term capital gain tax for upto 2687.2 units, with the assumption that you have already got the exemption of Rs 1 lakh of capital gain. Any units sold beyond that in the month of July will be taxed as short-term capital gain as it is assumed it is purchased in the month of August and units are held for less than one year.

ELSS 

Equity-linked savings schemes (ELSS) are tax saving instruments with a lock-in period of three years. They enjoy the benefit of Section 80C of IT Act. All the investment made in a financial year between March and April will be eligible for the deduction under Sec 80C, however, you will have to hold the units for a minimum of three years before selling them. For example, any unit you have bought in the month of April 2017 will have a lock-in till April 2020.

Debt funds 

Debt funds are treated differently as compared to the equity funds. The period of holding of your debt investment should be more than three years to qualify as long term. Any debt investment held for less than three years is treated as short term. The long-term capital gain in case of debt funds is taxed at the rate 20% with the benefit of indexation, without indexation benefit it is taxed at a rate of 10%. To calculate the long-term capital gains tax payable, you need to first calculate indexed cost of acquisition (Cost of acquisition*cost inflation index of the year of transfer/inflation index of the year of acquisition). After that, you will deduct the indexed cost of acquisition from consideration you received from the sale.

The short term capital gains tax in the case of debt fund is charged based on individual's income tax bracket. Therefore, if you are a salaried person and are taxed at the slab rate of 30%, your short-term capital gain on the debt fund will be taxed at the rate of 30%. In case you have invested in debt funds through SIP, it will also follow the FIFO method for any calculation of period of holding. The only thing that will change is the duration to ascertain whether long-term or short-term tax is applicable.

Taxation on mutual fund dividends 

The dividends on equity mutual funds were not taxed till last year, but now these will be taxed at the level of mutual fund houses,but it will be tax free in the hands of the investors. In the case of debt fund, mutual fund houses have to pay tax at the rate of 28.84% (5 per cent tax + 12 per cent surcharge + 3 per cent cess) on dividends.

How to know your mutual fund capital gain (loss) 

If you are a retail mutual fund investor and use SIP as an investment route in various funds, calculating tax amount will become tedious for you. It will be difficult for even financially savvy investors.

Therefore, its always advisable to get this information from some reliable source. There are two sources from where you can get this data. First is the AMC itself, which normally sends you capital gain/loss statement or you can ask the AMC to send it. The second source is Registrar and Transfer Agents (RTA) such as CAMS and Karvy and get the statement through their mailback services. You can get other important data from RTAs about your investment such as ‘grandfathered equity-oriented schemes. You just need to get registered through your mail ID.