Taxation Of Mutual Fund Investments

Shibu Das
Director, Fine Advice Pvt Ltd

When it comes to astute investment decisionmaking, you shouldn’t consider just the sources of investment returns but also the tax implications on your investments. Mutual fund investments are an optimal way to meet your financial goals keeping in mind your risk profile. However, depending on the type of return, asset class, investment time horizon and residential status, your mutual fund investment returns are subject to tax.

Sources of Returns

Mutual fund investments have two primary sources of returns. The first is the capital gains on the sale of the investment, and the second is the dividend income. Capital gains are simply the profit made on the sale of an investment. It is the difference between the purchase price and the selling price of a mutual fund unit. For example, if Ms. Anindita invested Rs 5 lakhs in a mutual fund scheme on April 1, 2019 and sold it on March 31, 2020 for Rs 6 lakhs, she earned a capital gain of Rs 1 lakh.

Taxation on Capital Gains

The taxation of capital gains made on a mutual fund investment depends on the type of mutual fund scheme and the investment period. Depending on the holding period, there are two types of capital gains; short-term capital gain (STCG) and long-term capital gain (LTCG). However, the periods are defined differently for equity mutual funds and debt mutual funds. In the case of equity-oriented schemes, holding period of more than 12 months is long term and in all other cases holding period of more than 36 months is long term.

Taxation on Equity Funds

Equity mutual funds by definition invest at least 65 per cent of the money in equities, with the remaining 35 per cent invested in various debt and money market schemes. In the case of equity funds, the gains made on an investment redeemed within 12 months from the date of allotment attracts STCG Tax at the rate of 15 per cent of profits. On the other hand, in the case of equity fund units, held and redeemed after a period of 12 months, the profit will be subject to LTCG Tax at the rate of 10 per cent. However, it is important to note that capital gains of up to Rs 1 lakh per annum are exempt from the LTCG Tax. For example, if an investor’s LTCG in FY 2019-20 is Rs 1.5 lakhs, only Rs 50,000 (Rs 1.5 lakhs less Rs 1 lakh) will be taxable as LTCG.

Taxation on Debt Funds

Debt mutual funds by definition allocate at least 65 per cent of the amount in various debt securities and money market instruments. They may have a minor allocation in equities. In the case of debt mutual funds, the gains made on an investment redeemed within 36 months from the date of allotment attract STCG Tax. Currently, STCG Tax on debt funds is as per the applicable tax slab rate of the investor. Gains on debt investments redeemed after a period of 36 months will be subject to LTCG Tax. The current LTCG Tax rate on debt mutual funds is 20 per cent with indexation benefits.

Taxation of Dividends

Dividends from a mutual fund were tax-free in the hands of investors until March 31, 2020, as the mutual fund declaring such dividend already paid Dividend Distribution Tax (DDT) before making the payment. Budget 2020 changed the method of dividend taxation. All dividends received on or after April 1, 2020 are taxable in the hands of the investor. Dividend Distribution Tax has been scrapped.

TDS on Dividends

From April 1, 2020, mutual funds deduct TDS at 10 per cent on the distribution of dividend, provided that the dividend paid per recipient exceeds Rs 5,000 in the financial year.

Tax Implications for NRIs

When it comes to mutual fund investments, the taxation rules for both resident Indians and non-resident Indians (NRIs) are the same. The only difference is in the way tax is deducted. In the case of resident Indians, there is no tax deducted at source (TDS). However, redemptions made by NRIs are subject to TDS at the highest tax rates. For example, in the case of NRIs, TDS on LTCG made in listed debt funds is 20 per cent (with indexation benefit) and 10 per cent for unlisted debt funds (without indexation benefit). Similarly, while there is no TDS for local investors on dividend income, NRIs are subject to TDS at the highest tax rates. For example, dividend income earned on debt funds is subject to 20 per cent TDS.

The writer is a Director, Fine Advice Pvt Ltd
 Email id : Shibu@Fineadvice.in
 Website : Www.fineadvice.in