Tax on Mutual Funds - How Gains from Mutual Funds are Taxed? | Motilal Oswal

How gains from mutual funds are taxed

There are various choices at the disposal of an investor when picking a mutual fund to invest in. Whether it be the tempting returns that equity funds showcase, the safety that is associated with debt funds or the hybrid funds that try to make the most of both these asset classes, the choices are many. Typically, factors such as past returns, indicative ratios and fund house credentials are taken into account, but one important factor is not talked about enough – mutual fund tax.

 

  • How mutual funds are taxed:

Mutual funds tax can be either charged on capital gains or on the dividends received from these funds. Following the 2020 budget, all dividend income by any mutual fund is taxed according to the investor’s respective income tax bracket. This means that dividends are added to one’s income and taxed according to their tax bracket. When it comes to mutual fund gains (a.k.a. capital gains), meaning the profit realized in selling the security higher than the purchase price, it is taxed depending on the type of fund and the duration the fund was held. Below are 4 types of funds and their respective taxation percentages:

  • Equity Funds:

1. Short Term Capital Gains (Shorter than 12 months): Taxed at 15% + cess + surcharge
2. Long Term Capital Gains (12 months and longer): Upto Rs. 1 Lakh a year exempt. Gains above Rs. 1 Lakh taxed at 10% + cess + surcharge
3. STT (Securities Transaction Tax): 0.001% charged by Govt.

  • Debt Funds:

1. Short Term Capital Gains (Shorter than 36 months): Taxed at investor’s income tax bracket rate
2. Long Term Capital Gains (36 months and longer): Taxed at 20% + cess + surcharge

  • Hybrid-Equity Oriented:

1. Short Term Capital Gains (Shorter than 12 months): Taxed at 15% + cess + surcharge
2. Long Term Capital Gains (12 months and longer): Upto Rs. 1 Lakh a year exempt. Gains above Rs. 1 Lakh taxed at 10% + cess + surcharge
3. STT (Securities Transaction Tax): 0.001% charged by Govt.

  • Hybrid-Debt Oriented:

1. Short Term Capital Gains (Shorter than 36 months): Taxed at investor’s income tax bracket rate
2. Long Term Capital Gains (36 months and longer): Taxed at 20% + cess + surcharge

  • How SIPs are taxed?

It is also important to remember that SIPs are purchased either weekly, monthly, quarterly or whichever plan you have picked as an investor. When redeeming these units, make sure that the units purchased earliest are redeemed first. For instance, redeeming equity mutual units purchased 2 years ago would invite long-term capital gains tax at 10% whereas redeeming units purchased 6 months ago would invite short-term capital gains tax at 15%. This is assuming that the profit is higher than Rs. 1 Lakh.

Conclusion

As seen above, mutual fund tax depends entirely on the categorization of the fund and how long an investor has held the investment in this fund. These factors are important to keep in mind while investing in these funds and when setting one’s financial goals in the first place.

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