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Are Mutual Funds Taxable

17 Jul 2023

Most investors fail to account for one major concept when planning to invest in mutual funds - taxation. They’re simply unaware of the applicability of tax on mutual funds. If you’re someone who is in the same league, then this article can help clear things out for you. Continue reading to find out whether mutual funds are taxable and, if they are, the different implications they carry. 

Are Mutual Funds Taxable

Yes. The returns from a mutual fund are considered to be capital gains under the Income Tax Act of 1961 and are taxable in the hands of the investor. That’s not all. Even dividends that investors receive from a mutual fund are liable for taxation. 

Tax on Dividends Arising From a Mutual Fund

Now that you’re aware that you would have to pay income tax on mutual funds, let’s now delve a little deeper and see how dividends are taxed. 

According to the pronouncements made in the Union Budget 2020, dividends from stocks and mutual funds should be added to your taxable income under the head ‘Income from Other Sources’ and would be taxed at the income tax slab rate applicable to you. So, for instance, if you fall under the 20% income tax slab, the dividends that you earn from a mutual fund would be taxed at 20%.  

Tax on Capital Gains Arising From a Mutual Fund

As you’ve already seen above, the returns or profit from a mutual fund investment is classified as capital gains under the Income Tax Act of 1961. 

However, the rate of tax applicable would be dependent on whether the capital gains are short-term or long-term in nature. The nature of the capital gains is determined by factors like the type of mutual fund that you invest in and the holding period. 

Here’s a table that can help you understand the concept in a much better manner. 

Mutual Fund

Short-Term Capital Gains

Long-Term Capital Gains

Equity Mutual Fund and Equity-Focused Hybrid Fund

If the holding period is less than 12 months

If the holding period is 12 months or above

Debt Mutual Fund and Debt-Focused Hybrid Fund

If the holding period is less than 36 months

If the holding period is 36 months or above

Tax on Equity Fund Capital Gains 

Mutual funds whose equity exposure is more than 65% are termed equity mutual funds. In the case of short-term capital gains from equity funds, the rate of tax that you would have to pay would be 15%.

On the other hand, in the case of long-term capital gains from equity mutual funds, it is exempted up to Rs. 1 lakh in a financial year. Capital gains exceeding Rs. 1 lakh, however, would be taxed at a flat rate of 10%. 

Tax on Debt Fund Capital Gains 

Mutual funds whose exposure to debt instruments is more than 65% are termed debt mutual funds. In the case of short-term capital gains from debt funds, they are added to your total taxable income and are taxed at the income tax rate that applies to you. 

In the case of long-term capital gains from debt mutual funds, the gains are taxed at a flat rate of 20%. However, you get the benefit of indexation.  

Tax on Hybrid Fund Capital Gains 

The taxation of capital gains from hybrid funds is dependent on whether it is equity-focused or debt-focused. In the case of equity-focused hybrid funds, the taxation methodology would be the same as that of equity funds. Similarly, in the case of debt-focused hybrid funds, the taxation methodology would be the same as that of debt funds. 

Securities Transaction Tax (STT) on Mutual Funds

In addition to income tax on mutual funds, you will also have to pay Securities Transaction Tax (STT) on the purchase and sale of units of equity mutual funds and equity-focused hybrid funds. The rate of STT payable by you is 0.001%. Securities Transaction Tax is not levied on the sale of units of debt mutual funds. 

Conclusion

With this, you must now be aware of everything related to tax on mutual funds. And as you can see, the longer you hold the mutual fund, the lower your tax liability is likely to be. So, if you’re planning on investing in mutual funds, make sure to hold it for the long term.

That said, to invest in a mutual fund, you need to have an active trading and demat account. With Motilal Oswal, you can quickly open a Demat account and a trading account for free within minutes. Once you open the account, you can use the robust trading platform of Motilal Oswal to invest in your favorite mutual funds and upcoming IPOs. 

 

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