What is Taxation in Mutual Funds: How it is Calculated & Taxed in India

Investing in mutual funds could be easy as well as more lucrative, especially for investors who don’t have the knowledge or experience to directly invest in equities and other investable instruments. You can earn profits from investments done in mutual funds. However, the profits earned from such investments through mutual funds are also taxable in India.

The policy of taxation for mutual funds keeps changing every year as per the new regime. Hence, understanding how income from mutual funds is taxable is very important to know how much taxes you need to pay if you earn profits from investing in such funds.

To make you comprehend this topic here in this article we are going to discuss the taxation on various types of funds in mutual funds, how it is calculated, and the slab rates on long-term or short-term capital gain tax on mutual funds in India.

An Overview of Taxation in Mutual Funds

Just like profits or capital gain earned from various assets, the profits earned from mutual fund investments are also liable to pay tax under certain terms and conditions. The capital gains are categorised into short-term capital gains and long-term capital gains as per the holding period defined by the income tax authorities and government agencies.

Short-term capital gain attracts higher tax rates than long-term capital gain. This is because the government wants to keep encouraging people to invest their money in such instruments from a long-term perspective. However, investors get a good amount of return in a shorter period usually liquidating their investment and investing in other assets.

Factors that Affect Mutual Fund Taxation

Apart from the taxation policy and rates, the taxation in mutual funds is affected by various factors. Holding period, types of funds, capital gains and dividends are the variables determining the taxation for mutual funds, let’s find out how they affect.

Type of Funds: The funds in the mutual fund industry are basically categorised into three types of funds – equity funds, debt funds and hybrid funds.

Holding Period: The duration of holding your investment is one of the major factors in determining the taxation of mutual funds. The longer the period you hold your investment, you have to pay lower taxation charges against the shorter-period holding period mutual funds.

Dividends: Dividends are the portion of profits distributed by the listed companies among the shareholders and mutual fund companies, who further distribute the same among the fund investors. These dividends income are liable for the taxation for the dividend holders.  

How do You Calculate Capital Gains on Mutual Funds?

In mutual fund investment, capital gains and dividends are the main sources of income. After investing in mutual funds, when you sell your units higher than your buying price the profit you earn is considered the capital gain. Similarly, the dividends received by the fund houses distributed among the investors are also taxable.

The eligibility and rate of taxation on funds are decided according to the different types of funds and the duration of redemption. Let’s find out how to calculate tax on mutual fund redemption on various funds for short-term and long-term capital gain taxes.

Taxation on Equity Mutual Funds

If you are liquidating your investment in equity mutual funds within one year, then you will be liable to pay the short-term capital gain (STCG) tax at the rate of 20% as per the latest slab rate revised by the finance ministry in India.

If you redeem your investment in more than one year, then the profit you earned from selling the mutual fund units will be liable under the long-term capital gain (LTCG). As per the latest tax slab rate for LTCG in equity, you have to pay 12.5% tax on profits you earn.

Taxation for Debt Mutual Funds

The capital gains from the debt funds are calculated with different rates as per the redemption done within three years or more than three years. If you sell, your debt funds units in less than three years the profits earned from debt funds are considered as the short-term capital gain (STCG).

However, if your investment in debt funds crosses three years, and you sell the same, it will be eligible to be taxed under the long-term capital gain (LTCG) as per the slab rates for such funds.

Taxation for Hybrid Mutual Funds

Hybrid funds consist the investable instruments like equity and debt, and the profit earned from such income earned within one year is taxed as STCG. While keeping the hybrid funds for more than a year and then selling in profits is taxed as the LTCG.

Taxation on Gold Mutual Funds

Apart from equity, debt and hybrid funds, if you have invested your money in the gold fund, then again selling the gold fund units in less than three years will be taxed under the short-term capital gain (STCG). If you sell the gold funds after waiting more than three years, then capital gained from the selling of such investment in gold funds is taxed under LTCG.

Taxation on Liquid Mutual Funds

Liquid funds are short-term funds with a maturity duration of 91 days. The investable instruments are treasury bills, commercial papers and certificates of deposits. AMCs and mutual fund companies that invest in such instruments are called liquid funds. And the profit earned from such liquid funds is taxed under the short-term capital gain.

Dividend from Mutual Fund Taxation

Under the Finance Act 2020, the income earned from the dividends is taxable as per the slab rates with certain terms and conditions. AMCs and mutual fund companies deduct the Tax Deducted at Source (TDS) at the rate of 10% on the dividends up to Rs Rs 5000 earned by the investors.

To get the dividends claimed without deduction investors need to submit the Form 15G or Form 15H to mutual fund companies. Senior citizen enjoying nil tax liability also needs to submit Form 15H to the company deducting the dividend.

How are Mutual Funds Taxed in India?

The taxation policy for the mutual funds is applied as per the different types and categories of funds. The income earned or capital gain from mutual fund investment is taxed as per the time duration of investment and redemption of the funds.

To calculate the tax on mutual funds you have to simply find out the total profit after deducting all the cost and commission or brokerage charges paid on such profits. Now check the duration of your investment and apply the applicable rates to know the actual tax you need to pay on the income earned or generated from the mutual fund investments.

Conclusion: How to Avoid Tax on Mutual Funds?

The profits earned from mutual fund investment are categorised as short-term capital gain and long-term capital gain. Dividend income from mutual fund investments is also eligible to be taxed, hence investors get the dividends after TDS deduction done by fund houses.

You can reduce your tax liability on the profits earned from the mutual funds if you keep your investment for the long term, as the tax rates on the LTGC are lower than STCG. And under section 80C of the Income Tax Act, you can avail the tax deduction of up to Rs 1.5 lakh if you earned the profits from the investments done through the Equity-Linked Savings Scheme (ELSS).

• Author: Religare Broking
• Last Updated: December 4, 2024