There are very few things in this world which are both “Legal” & “Lethal”. TAX is one of them. If not understood or paid in a proper way, it is enough to give you hypertension which is one of the most common reasons for a heart stroke. See, I made you look gloomy and stressful. Hence it is very important to have elementary knowledge of Tax Provisions.
I believe most of the readers are new to the Mutual Funds so they will have many queries on taxation of Mutual Funds. So, here is an attempt to cover Mutual Fund Taxation for individuals, HUF & NRIs.
Income from Mutual Fund can be divided into 2 parts Capital Gain (increase in value of your investment) or dividends that investors receive on regular intervals if they have opted for dividend plans. So taxation of Mutual Funds in India can be divided in 2 parts Capital Gain & Dividends.
Capital Gain Taxation on Mutual Funds
Capital Gain is appreciation in the value of asset – if you buy something for Rs 1 Lakh & sell it for Rs 1.5 Lakh, you have made a Capital Gain of Rs 50000. Capital Gains are further divided into short term & long term depending on their investment horizon.
Short term capital Gain arises if investment is hold for less than 1 year or in simple words sold before completion of 1 year. Here 1 year means 365 Days.
Long Term Capital Gain arises if investment is sold after 1 year.
Mutual Fund Capital Gain Tax further depends on which type of fund it is – Equity or Debt.
Must Read – 11 Unusual ways of smart tax planning
Capital Gain Tax on Equity Mutual Funds
Equity Mutual Funds are those funds where equity holding is more than 65% of the total portfolio so even balanced funds will be categorized in Equity Funds. Fund of Funds (mutual funds which invests in other funds) & international funds (funds which have more than 35% exposure to international equities) will be kept under debt category for tax purpose.
Long Term Capital gain on Equity Mutual Funds – if you buy & hold an equity Mutual Fund for more than 1 year, there will be NIL Tax. Eg. If you invest Rs 1 lakh in XYZ Fund & after 1 year, its value is Rs 1.3 Lakh – there will be zero tax on capital appreciation of Rs 30000. This is a very big advantage of equity mutual funds.
Short Term Capital gain on Equity Mutual Funds – if you sell equity mutual fund before completion of 1 year you need to pay tax of 15% on capital gains. In the above example where gain was Rs 30000 – if this was a short term capital gain, investor would have paid Rs 4500 as short term Capital Gain.
Note for NRIs – Same capital gain is applied for NRIs but in case of Short Term Capital Gain there will be a TDS (tax deducted at source). Which means Tax will be deducted by Mutual Fund Company before paying redemption (sell) amount.
Capital Gain Tax on Debt Mutual Funds
All other funds which will not qualify as equity fund, including Fund of Fund & international Fund will be part of debt mutual funds. Definition of Short Term & Long Term is same as mentioned in equity category.
Short Term Capital gain on Debt Mutual Funds – any short term capital gain that arises due to selling of debt fund before 1 year will be added to investor’s income. Once it is added to income it will be taxed according to tax slab of that individual.
Long Term Capital gain on Debt Mutual Funds – here taxation depends on whether investor would like to use indexation or not. (To understand more on indication read this article – Taxation on Fixed Maturity Plans.
- Without Indexation – 10% tax on capital gains
- With Indexation – 20% tax on capital sains
Note for NRIs – NRIs will receive their redemption amount only after tax:
- Short Term – 30% TDS
- Long Term – 20% TDS
- Cess of 3% will also be applied to this TDS.
Shailesh asked couple of questions regarding capital gain taxation on mutual funds – hope this will help you to understand the concept better:
“I know that some short term as well as long term tax need to paid on redemption of mutual fund, but I don’t know where to pay and how much to pay.
Can you please take following scenario and help me out to calculate tax?
Suppose my salary income is Rs. 8,50,000 per annum, I am in 20% tax slab. Apart from that only mutual fund income is there.
1. I have purchased Equity mutual fund Rs. 10000 on 20-04-2010 and sold it on 20-10-2011 and Redemption money is Rs.11000. How much long term capital tax I need to pay in this year?
Ans. Here Long Term Capital Gain on Equity is applied – So NIL tax.
2. I have purchased Equity mutual fund Rs. 10000 on 20-04-2011 and sold it on 20-10-2011 and Redemption money is Rs.11000. How much short term capital tax I need to pay in this year?
Ans. Here Short Term Capital Gain on Equity is applied – So 15% tax on gains or Rs 150.
3. I have purchased Debt mutual fund Rs. 10000 on 20-04-2010 and sold it on 20-10-2011 and Redemption money is Rs.11000. How much long term capital tax I need to pay in this year?
Ans. Here Long Term Capital Gain on Debt is applied – So 10% tax or Rs 100 (I am assuming that Indexation is not used).
4. I have purchased Debt mutual fund Rs. 10000 on 20-04-2011 and sold it on 20-10-2011 and Redemption money is Rs.11000. How much short term capital tax I need to pay in this year?
Ans. Here Short Term Capital Gain on Debt is applied – so appreciation of Rs 1000 will be added to your income tax & taxed according to your slab.
5. I have purchased hybrid mutual fund(say HDFC Balanced) Rs. 10000 on 20-04-2010 and sold it on 20-10-2011 and Redemption money is Rs.11000. How much long term capital tax I need to pay in this year?
Ans. As I told you earlier that balanced funds or funds with more than 65% in equities are qualified as Equity Funds – so answer will be same as question 1.
6. I have purchased hybrid mutual fund(say HDFC Balanced) Rs. 10000 on 20-04-2011 and sold it on 20-10-2011 and Redemption money is Rs.11000. How much short term capital tax I need to pay in this year?
Ans. Same as Question 2”
Hope now you have clear idea about capital gains. Let’s see second part of income from mutual fund – that is Dividend Income.
Mutual Fund Dividend Taxation
Again this taxation will depend on which type of Mutual Fund you are investing in – Equity or Debt.
There is no dividend distribution tax on equity mutual funds & also the dividend received by investors is tax free. So, again a bonus for equity mutual fund investors.
Even in case of Debt Mutual Funds – dividends received by investor are tax free in their hand or they don’t need to show it as a taxable income. But there is dividend distribution tax paid by mutual funds to income tax department.
Dividend Distribution Tax on Debt Mutual Funds
Here there are many tax slabs depending on the investor category but we will only be talking about Individuals, HUF & NRIs.
This taxation further depends on type of Debt Funds:
Dividend Distribution Tax on Liquid/Money Market Schemes
Liquid/Money Market Schemes means Debt oriented funds which invest in money market instruments or in securities that have maturity of less than 90 days.
Here 27.038% tax (25% Tax + 5% Surcharge + 3% Cess) will be deducted from the dividends.
Dividend Distribution Tax on Debt Funds other than Liquid/Money Market Schemes
Here 13.519% tax (12.5% Tax + 5% Surcharge + 3% Cess) will be deducted from the dividends.
In equity mutual funds there is not much difference whether you invest in a growth or dividend option. (Leaving 2-3 special cases) In debt it is very important that investor should select dividend or growth depending on his time horizon & tax slab.
According to the Finance Bill 2013, the DDT applicable for debt funds has increased from 12.5 per cent to 25 per cent for individuals and HUFs. DDT applicable to any person other than an individual or HUF i.e. a firm, or a company, continues to be 30 per cent.
If you still have any query related to Mutual Fund Taxation – feel free to ask. If you think this article was helpful to understand this concept, must share it with your friends.