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Tax implications while investing in Mutual Funds
05 Jan 2023

Mutual funds are one of the most popular investing alternatives since they assist you in achieving your financial objectives. Mutual funds are also a tax-saving investment. Because interest is added to your taxable income and taxed at the rate established by your income tax slab, fixed deposits have a considerable disadvantage, particularly if you are in the highest income tax bracket.

  • How Do You Make Money With Mutual Funds?

Dividends and capital gains are two types of rewards offered by mutual funds. Dividends are paid from the company's earnings, provided any exist. When businesses have excess cash, they may choose to distribute it to shareholders in the form of dividends. Dividends are paid out in proportion to the amount of mutual fund units owned by investors.

A capital gain is the profit made by investors when the selling price of the securities they own exceeds the acquisition price. To put it another way, capital gains are realized when the price of mutual fund units rises. Dividends and capital gains are both taxable in the hands of mutual fund investors.

  • Capital Gains Taxation for Equity Funds

Mutual funds with a portfolio equity exposure of more than 65 percent are called equity funds. As previously stated, short-term capital gains are realized when you redeem your equity fund units during a one-year holding period. Regardless of your income tax status, these profits are taxed at a flat rate of 15%.

When you sell your stock fund units after a one-year or longer holding period, you earn long-term capital gains. These capital gains are tax-free up to Rs 1 lakh each year. Any long-term capital gains in excess of this amount are subject to LTCG tax at a rate of 10%, with no indexation advantage.

  • Capital Gains Taxation for Debt Funds

Debt funds are mutual funds with a debt exposure of more than 65 percent in their portfolio. Redeeming your debt fund units during a three-year holding period results in short-term capital gains.

Long-term capital gains are realized when you sell debt fund units after a three-year holding period. After indexation, these profits are taxed at a flat rate of 20%. You will also be charged the relevant cess and surcharge on tax.

  • When Investing Through SIPs, Capital Gains Are Taxed

Systematic investment plans (SIPs) are a kind of mutual fund investment. They are created in such a manner that investors may invest a little sum in a mutual fund scheme on a regular basis. Investors have the option of selecting the frequency of their investments. Weekly, monthly, quarterly, bi-annually, or yearly are all possibilities.

With each SIP installment, you buy a set amount of mutual fund units. These units are redeemed in the order in which they were received. Assume you make a one-year SIP investment in an equities fund and decide to redeem your full investment after 13 months.

The units acquired initially via the SIP are kept for a long time (over a year) in this scenario, and you realize long-term capital gains on them. You don't have to pay any tax if your long-term capital gains are less than Rs 1 lakh.

From the second month onwards, however, you earn short-term financial gains on the units acquired via SIPs. Regardless of your income tax status, these profits are taxed at a flat rate of 15%. On top of that, you'll have to pay the relevant cess and fee.

Wrapping Up

The longer you keep your mutual fund units, the lower your tax bill will be. Long-term capital gains are taxed at a lower rate than short-term capital gains.

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