This is how mutual funds are taxed!
Mutual funds have been a great investment vehicle for investors in wealth creation as well as for achieving their financial goals. The biggest factor, which eats up your wealth creation, is taxation. Investors should consider taxation before investing in any instrument. Mutual funds are tax-efficient instruments as compared to bank fixed deposits. Fixed deposit interest is taxed as per the income slab rates, which is even worse for higher income tax brackets. This is why investment in mutual funds is beneficial as it delivers tax-efficient returns. Mutual funds offer returns to their investors in the form of capital gains and dividends. So, in this article, we will look at how these returns are taxed.
Mutual funds offer a variety of schemes such as equity-oriented schemes, debt-oriented schemes, and hybrid schemes. All of these schemes are taxed in a different manner.
The following table explains the taxation of various mutual fund schemes:
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Scheme Type
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Short Term Capital Gains
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Long Term Capital Gains
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Equity-oriented schemes
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Capital gains arising within 12 months are termed as short-term capital gains (STCG). They are taxed at the rate of 15 per cent.
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Capital gains arising after 12 months are termed as long-term capital gains (LTCG). They are exempted up to Rs 1 lakh. Gains in excess of Rs 1 lakh are taxed at the rate of 10 per cent without indexation.
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Debt-oriented schemes
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Capital gains arising within 36 months are termed as STCG. They are taxed as per the investors’ slab rate.
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Capital gains arising after 36 months are termed as LTCG. They are taxed at the rate of 20 per cent with indexation benefit.
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Hybrid Schemes
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The taxation of hybrid funds is dependent upon the exposure of equity in the scheme. If equity exposure exceeds 65 per cent, then it will be taxed as per equity-oriented scheme but if its equity exposure does not exceed 65 per cent, then it will be taxed as per the debt-oriented scheme.
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Hybrid equity-oriented scheme
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Capital gains arising from this scheme within 12 months is termed STCG. They are taxed at the rate of 15 per cent.
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Capital gains arising after 12 months are termed as LTCG. They are exempted up to Rs 1 lakh. Gains in excess of Rs 1 lakh are taxed at the rate of 10 per cent without indexation.
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Hybrid debt-oriented schemes
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Capital gains arising within 36 months are termed as STCG. They are taxed as per the investors’ slab rate.
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Capital gains arising after 36 months are termed as LTCG. They are taxed at the rate of 20 per cent with indexation benefit.
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Taxation on dividends:
As per Budget 2020, dividends will be taxed in the hands of investors. No domestic company or mutual fund will be required to pay dividend distribution tax (DDT). The incidence of tax will be on the recipient and not on the payer i.e., mutual fund or a domestic company. Dividends received by investors will be added to their taxable income and will be taxed as per the income tax slab rates unlike previously where DDT was paid by the domestic company or mutual fund. Due to this amendment, individuals falling under higher income tax brackets will get adversely affected as compared to individuals falling under lower income tax brackets.
Taxation on SIP:
SIP or systematic investment plan offers investors to invest in small amounts on a regular basis, which leads to taxation in a different manner as compared to lump-sum investment. The redemption of SIP is on the basis of a first-in-first-sell basis and accordingly, they are taxed. For instance, you started your investment on January 1, 2020, in an equity fund and redeemed it on December 31, 2020, then your first-month investment will be LTCG as it was held for 12 months and would be exempted up to Rs 1 lakh and taxed at the rate of 10 per cent without indexation if capital gains are in excess of Rs 1 lakh. And from the second month, the investment will be STCG as they were held for less than 12 months and will be taxed at the rate of 15 per cent. Same way, if SIP investment is done in a debt fund, then capital gain arising within 36 months will be STCG and taxed as per the income tax slab rate. On the other hand, if capital gain arises after 36 months, then it will be LTCG and taxed at the rate of 20 per cent with indexation benefit.