Taxability on mutual funds, 3 ways to save LTCG tax
Mutual funds are a popular investment option since they help you reach your Financial Objectives. Mutual funds are a tax-advantaged way to invest. Fixed deposits pose a major disadvantage, especially if you are under the highest income tax range. Interest is added to taxable income and is taxed at the tax Rate set on the income tax plate. In this sector, mutual funds are compelling. You gain the advantage of competent money management and tax-efficient returns when investing in a mutual fund.
If you are a mutual fund investor or plan to invest, you must understand how your mutual fund returns will be taxed. Mutual fund profits and gains are taxed, just like most other asset types you invest in. Because taxes are difficult to avoid, it’s a good idea to familiarize yourself with the tax requirements for mutual funds before you begin investing. Knowing how mutual funds are taxed may help you plan your investments to reduce your overall tax bill; this post will cover all aspects of mutual fund taxes.
What Is The Best Way To Make Money With Mutual Funds?
Mutual funds provide two forms of rewards: dividends and capital gains. Dividends are paid from the profits of the company. If there are any, when a company has surplus Cash, it may opt to distribute it to its shareholders in the form of dividends. Investors get dividends in percentage to the number of mutual fund units they possess.
The profit realized by investors when the selling price of the securities they hold exceeds the purchase price is known by the term capital gain. Put another way, when the cost of mutual fund units rises, capital gains are achieved. In the hands of mutual fund investors, dividends and capital gains are equally taxable.
Key Factors Affecting Mutual Funds Taxation in India
It’s much easier to understand the ideas of mutual fund taxes if you break them down into smaller chunks. So, let’s begin by evaluating the aspects that determine your mutual fund tax liability.
The taxation of mutual funds in India is based on three main factors:
Types of investments: For tax reasons, mutual funds are divided into equity and debt-oriented mutual funds.
The nature of the gains (capital gains or dividends): Capital gains are earned when you sell a capital asset for more than it cost, while a dividend is a percentage of the mutual fund house’s earnings that it distributes to the scheme’s investors (dividends do not need an investor to sell the asset). In the next part, we’ll go through what they are and how each of them is taxed.
Your waiting duration is as follows: The holding period determines the Rate of tax you’ll pay on your capital gains. If you maintain your Assets for a more extended period, you will pay less tax.
Longer holding periods are encouraged by India’s income tax legislation. Thus, keeping your investment for longer minimizes your tax exposure.
How Are Profits Generated in Mutual Funds?
Mutual funds provide income to investors through capital gains or dividends. Let’s better understand what they are and how they vary.
The profit earned from selling an asset at a higher price than its cost is a capital gain. For example, if you own units in a mutual fund scheme that you bought when the NAV was 140, and you sell them when the price rises over 140, you would profit.
It’s worth noting that capital gains are recognized only when mutual fund units are redeemed. As a result, the mutual fund capital gains tax is only applied at the time of redemption. As a result, the tax on mutual fund redemption will have to be paid when the income tax returns for the next fiscal year are filed.
Dividends are another method for mutual fund investors to profit from their investments. The mutual fund pays out dividends based on the distributable surplus it has amassed. Dividends are paid out at the discretion of the fund and are taxed when the investors receive them. When investors get dividends from mutual funds, they must pay tax on them. Next, we’ll go through the old and new mutual fund dividend tax laws.
Dividends are taxed in three ways.
The 2020 Finance Law has been amended to abolish the dividend distribution tax. Prior to March 31, 2020, dividend income from investment trusts was tax-exempt for investors. Fund companies deducted dividend distribution taxes (DDT) before delivering dividends to mutual fund investors. In the hands of the investor, the total dividend income is now taxed according to the income tax slab under the heading “income from other sources.”
TDS (tax deducted at source) is relevant to the mutual fund scheme’s dividend distribution. According to the new guidelines, if the total dividend paid to an investor during a financial year exceeds 5,000, the AMC shall deduct 10% TDS u/s 194K when the mutual fund pays the dividend to its investors. When you pay your taxes, you can claim the 10% TDS that the AMC has already deducted and merely pay the difference.
Capital Gains Taxation
The amount of tax you pay on mutual fund capital gains is determined by the type of mutual fund scheme you own and how long you’ve owned the scheme’s units. Let’s have a look at the two aspects in more depth.
1. Holding period
Let’s start with defining the words long-term capital gains (LTCG) and short-term capital gains (STCG). The capital gain gained from an asset kept for a long time (i.e., a long holding period) is referred to by the term LTCG, while the capital gain generated from Assets held for a shorter time is referred to by the term STCG.
Or tax purposes, the terms “long-term” and “short-term” are different for equity and debt schemes. For example, to be considered long-term, your holding duration on mutual funds must be at least 12 months for equity-oriented schemes and 36 months for debt-oriented schemes. The table below summarizes the holding periods necessary for capital gains to be classified in the long or short term.
The Orientation of the scheme
The tax on capital gains is decided by the type of mutual fund you invest in after you know your holding period. Mutual funds are divided into two categories: equity and debt. However, it’s necessary to discuss hybrid funds to understand how they’re taxed. Let’s take a closer look at the taxability of mutual funds in each category.
Taxation on Equity
For tax reasons, an equity-oriented mutual fund scheme is one that invests at least 65 percent of its Assets in Indian stocks or equity-related derivatives. For tax reasons, all other funds are classified like debt-oriented schemes.
Mutual Fund Long-Term Capital Gains: Equity Schemes
LTCG on the sale of equity shares or equity-oriented mutual fund schemes was formerly exempt under section 10(38). However, this was amended in 2018. According to section 112A of the Income Tax Act of 1961, LTCG income tax on mutual funds (equity-oriented schemes) is taxed at a Rate of 10% on capital gains in excess of Rs. 1 lakh.
For example, if you earned $120,000 in LTCG through an equity-oriented scheme in a fiscal year, your tax Rate will be 10% (plus applicable cess and surcharges), regardless of your income tax bracket.
Mutual Fund Short-Term Capital Gains: Equity Schemes
Section 111A of the Income Tax Act, 1961, imposes a 15% STCG tax on the sale of units in equity-oriented mutual fund schemes. For example, if you earned $130,000 in STCG through an equity-oriented plan in a given year, your tax will be computed on that amount at 15% (plus applicable cess and surcharges), independent of your income tax bracket. This is because, unlike LTCG tax, the $1 million exemption does not apply to STCG tax.
Equity-Linked Savings Scheme (ELSS)
ELSS is a type of mutual fund that invests at least 80% of its Net Assets in stocks. This is the plan for you if you’re seeking mutual fund tax benefits. Under section 80C of the Income Tax Act, 1961, money invested in an ELSS is deductible up to 1.5 lakh. It’s worth noting that section 80C has a limit of 1.5 lakh dollars. If you at present claim deductions for other things allowed under Section 80C, like LIC premiums, the amount deductible for your ELSS payments will be reduced.
How Do I Report Mutual Fund Investments on My ITR?
When you redeem your mutual Fund Assets, you must include the information in your ITR file. You’ll need to have all pertinent information, like the date of purchase and the date of sale.
You probably generate a Capital Gains Statement that automates these calculations if you invest with ET Money. You won’t have to manually calculate your short- and long-term capital gains because the statement automatically separates them. Investors are struggling to figure taxes on investment trust investments made before January 31, 2018, when Finance Secretary Arun Jetley enacted his grandfather’s rules.
ET Money does these computations, so you don’t have to waste time researching tax legislation on the internet.
Select ITR-2 (if you’re a salaried person with capital gains) or ITR-3 (if you’re a self-employed person with capital gains) when declaring mutual fund investments on your ITR (if you have income from business and profession). You may either use the ET Money statement to enter data relating to the date and amount of purchase and sale, transfer expenses, and a few other factors when adding capital gains details.
Section 80 C: The Best Tax-Avoiding Investment Option
Section 80C: The greatest tax-saving alternative is to invest in an ELSS fund or a Tax Saving Mutual Fund. These funds are specifically intended to provide you with the combined benefit of reducing taxes while increasing your investment returns.
ELSS investments can save you up to Rs 46,800 in taxes.
The shortest locking time is three years.
Higher returns than FDs, PPFs, and NPSs in the past.
The interest you earn is partially taxed.
Other Investment Options under Sec 80C
Tax-saving FDs are similar to regular fixed deposits, except they include a 5-year lock-in term and a tax reduction under Section 80C on investments up to Rs 1.5 lakh.
Eligibility: Resident Indians are eligible to apply.
Fixed Deposits have a 5-year liquidity lock-in period.
Interest Rates: Depending on the bank, the interest Rate on FDs ranges from 5.5 percent to 7.75 percent.
Investment Limit: The minimum investment amount is Rs 1000.
Interest is taxed when it is earned.
Investments in PPF (Public Provident Fund)
PPF (Public Provident Fund) investments are long-term investments backed by the Indian government. Tax deductions are available for deposits made in a PPF Account under Section 80C.
Eligibility: Residents of India, both paid and non-salaried, are eligible to apply. A HUF is not eligible to open a PPF Account.
PPF Accounts have a 15-year lock-in term, which can be extended by another five years. After seven years, partial withdrawals are allowed.
Interest Rate: The current interest Rate is 7.1 percent per annum.
Investment Limits: Rs 500 and Rs 1.5 lakh are the minimum and maximum investment limits, respectively.
Interest is tax-free when it is earned.
Investments in EPF (Employee Provident Fund)
All salaried employees are eligible for the EPF, which is a retirement benefit plan. This is equal to 12% of a worker’s base pay plus DA, deducted by the employer and put in the EPF or other recognized provident fund.
Employees with a base salary of more than $15,000 per month are eligible to apply.
Liquidity: Can withdraw PF balance after two months of leaving a job if he or she does not reapply for work within two months with a PF Act-covered company.
Interest Rate: The EPF’s interest Rate for the fiscal year 2020-21 is 8.5 percent.
Limit on investment: Both the employer and the employee must contribute a minimum of 12% of basic pay + D.A.
If withdrawn after five years of continuous service, the whole PF amount (including interest) is tax-free. However, if an employee’s EPF/VPF contribution exceeds Rs. 2.5 lakh in a given year, the interest generated on that excess contribution is now taxable; however, when the employer has not contributed to the fund, the maximum is extended to Rs. 5 lakh (i.e., for government employees).
Investing in the NPS (National Pension System)
The NPS is a pension program established by the Indian government to provide a pension to the unorganized sector and working professionals once they retire. Section 80C allows for tax deductions on investments of up to Rs 1.5 lakh. Over and beyond the Section 80C limit of Rs 1.5 lakh, an additional Rs 50,000 deduction is possible for NPS contributions.
Qualifications: All Indian citizens between the ages of 18 and 60 are eligible to apply.
Liquidity: After ten years, partial withdrawals are permitted, but only under certain circumstances.
Rate of Returns: The NPS returns Rate fluctuates between 12 and 14 percent.
Maximum Donation: There is no maximum contribution restriction.
Employer contributions are tax-free, up to a maximum of 10% of the base wage and dearness allowance (14 percent for Central/State government employees).
Investments in ULIP (Unit-linked Insurance Plans)
ULIP is a type of insurance that doubles like an investment. A percentage of the money invested in ULIPs is used to provide insurance, while the balance is put into the stock market. Under Section 80C, ULIP investments of up to Rs 1.5 lakh are eligible for tax benefits.
Investors can buy ULIP for themselves, their spouse, or their children. Interest rates are market-linked and therefore fluctuate. Response Rate: ULIP response Rates range from 12 to 14 percent.
Maximum Donation: There is no maximum contribution restriction.
All investments, withdrawals, and maturities are tax-exempt. However, the proceeds of such ULIPs would be taxed if the yearly premium exceeds Rs 2.5 lakh in any year throughout the policy’s term.
Sukanya Samriddhi investments Yojana
Sukanya Samriddhi Sukanya Samriddhi Sukanya Samridd The Government of India’s Yojana/Scheme is one of the most popular initiatives. The project aims to improve the lives of girls in the country.
Eligibility: Parents/guardians can create an Account in their daughter’s name until she becomes ten years old.
Interest Rate: The interest Rate on the Sukanya Samriddhi Yojana is 7.6%.
Investment Limit: A financial year’s investment is limited to a maximum of Rs.1,50,000.
All investments, withdrawals, and maturities are tax-exempt.
Mutual fund taxation isn’t complicated like one may believe. The taxes of mutual funds is mainly determined by the holding duration and whether the scheme is equity or debt-oriented. It may be intimidating to have to manually calculate everything when the return filing deadline is only a week away.
Taxation of Dividends Offered by Mutual Funds
According to the revisions proposed in the Union Budget 2020, dividends paid by any Mutual fund scheme are taxed in a conventional manner. Investor dividends are added to taxable income and are taxed at the tax Rate applicable to a particular income tax plate.
Because companies paid dividend distribution tax (DDT) before sharing revenues with shareholders in the form of dividends, payouts were formerly tax-free in the hands of investors.
During this time, dividends (received from domestic companies) of up to Rs 10 lakh were tax-free in the hands of investors. Dividends in excess of Rs 10 lakh were subject to a 10% dividend distribution tax each financial year.
Taxation of Capital Gains Offered by Mutual Funds
Mutual Funds Provide Capital Gains Taxation
Mutual fund capital gains tax rates are based on the holding duration and mutual fund type. The holding time refers to how long a mutual fund unit was retained by an investor. Simply put, the holding period is the period from the purchase of the investment fund’s stock to the sale. The following are the classifications for capital gains realized on the selling of mutual fund units:
| Fund Type | Short-term capital gains | Long-term capital gains |
| Equity funds | Shorter than 12 months | 12 months and longer |
| Debt funds | Shorter than 36 months | 36 months and longer |
| Hybrid equity-oriented funds | Shorter than 12 months | 12 months and longer |
| Hybrid debt-oriented funds | Shorter than 36 months | 36 months and longer |
Mutual funds’ short-term and long-term capital gains are taxed at several Rates.
Taxation of Equity Funds’ Capital Gains
Equity funds are mutual funds with a portfolio equity exposure of higher than 65 percent. Short-term capital gains are earned when you redeem your equity fund units during a one-year holding period, explained before. These gains are taxed at a Fixed Rate of 15% regardless of your income tax status.
Long-term capital gains are earned when you sell stock fund units after a one-year or longer holding period. Up to Rs 1 lakh in capital gains is tax-free each year. Long-term capital gains above this amount are subject to a 10% LTCG tax and have no indexing benefits.
Taxation of Capital Gains of Debt Funds
Debt funds are mutual funds with a portfolio of over 65% debt exposure. As demonstrated in the table above, redeeming your debt fund units during a three-year holding period results in short-term capital gains. These earnings are included in your taxable income and taxed at the Rate that applies to your tax bracket.
Selling shares in a debt fund after a three-year holding period can provide long-term economic benefits. These profits are taxed at a fixed Rate with a 20% index. You will be charged applicable taxes and fees.
Taxation of Capital Gains of Hybrid Fund
The equity exposure of a hybrid or balanced fund’s portfolio determines the capital gains tax Rate. The fund plan is taxed like an equity fund if the equity exposure is higher than 65 percent; otherwise, the taxation rules for debt funds apply.
As a result, it’s important to understand the hybrid scheme’s equity exposure before investing; otherwise, you could be surprised when it’s time to redeem your fund units.
Capital Gains Are Taxed When Investing Through SIPs
Mutual fund investments in the form of systematic investment plans (SIPs) are a type of mutual fund investment. They are designed in such a way that investors can invest a small amount on a regular basis in a mutual fund scheme. Investors have the option of choosing their investment frequency. Weekly, monthly, quarterly, biannually, and annually are all options.
You acquire a certain number of mutual fund units with each SIP installment. The redemption of these units takes place in the sequence in which they were received. Assume you invest in an equities fund for a year and want to redeem your whole investment after 13 months.
In this scenario, the units purchased first through the SIP are retained for a long period (over a year), resulting in long-term financial gains. If your long-term capital gains are less than Rs 1 lakh, you won’t have to pay any tax.
However, you begin to generate short-term financial benefits on the units obtained through SIPs after the second month. These gains are taxed at a Fixed Rate of 15% regardless of your income tax status. You’ll have to pay the applicable cess and levy.
Tax on Securities Transactions (STT)
There is a Securities Transaction Tax in addition to the dividends and capital gains taxes (STT). The government (Ministry of Finance) levies a 0.001% STT when you buy or sell mutual fund units in an equity Fund or a hybrid equity-oriented fund. The STT does not apply to the sale of debt fund units.
Your tax payment will be reduced if you maintain your mutual fund units for a longer period of time. The tax Rate on long-term capital gains is lower than that on short-term capital gains.
Tax Benefits of Investing in Mutual Funds
Many investors underestimate the tax ramifications while making investment decisions. An investor may be pleased with a fixed deposit plan that pays 8–9% interest, for example. If interest income is fully taxable, like it usually is, the effective post-tax return for the highest tax bracket investor is just 5.6–6.3 percent. In a middle-income or upper-middle-income urban Indian investor’s average spending basket, this return may not be enough to keep up with inflation.
For Indians, mutual funds, on the other hand, are one of the most tax-efficient investment options. When it comes to mutual funds, it’s important to understand that taxation only applies when units of a mutual fund scheme are sold.
Let us now look at the tax benefits of mutual funds –
Tax on mutual funds that invest in stocks (funds that have at least 65 percent equity allocation in their investment portfolios). Long-term capital gains in equity funds must be held for at least one year. If sold under one year, short-term capital gains in equities funds are taxed at a Rate of 15% + 4% cess. If the gain on equity funds surpasses Rs 1 lakh in a financial year, the long-term capital gains tax is 10% + 4% cess. Long-term capital gains worth up to Rs 1 lakh are tax-free.
In the hands of the investor, dividends paid by equities mutual funds are tax-free, but the AMC must pay an 11.648 percent dividend distribution tax (DDT).
Tax on debt mutual funds – A three-year holding period is necessary for short-term capital gains in debt funds. Short-term capital gains on debt mutual funds (if sold under three years) are taxed at the investor’s marginal tax Rate. As a result, if your marginal tax Rate is 30%, your short-term capital gains tax on borrowed money will be 30% + 4%. Long-term capital gains from debt funds are taxed at 20% with indexation.
To calculate the capital gains from indexing, multiply the purchase price by the ratio of the inflation index of the year of purchase to the inflation index of the year of the sale, then subtract the indexed purchase price from the sales price. Indexation benefits reduce a debt fund investor’s tax obligation greatly in comparison to bank FDs and many small savings plans.
Dividends are tax-exempt in the hands of investors, but fund houses must pay a dividend distribution tax (DDT) of 29.120% before paying investors.
Your tax payment will be reduced if you maintain your mutual fund units for a longer period of time. The tax Rate on long-term capital gains is lower than that on short-term capital gains.
Under Section 80C of the Income Tax Act of 1961, investments in Equity Linked Savings Schemes, or ELSS mutual funds, are deductible from taxable income. Under Section 80C, the maximum amount of investment that may be deducted is Rs 1.5 lakhs. Investors in the highest tax bracket (30%) can save up to Rs 46,350 in taxes by investing in ELSS mutual funds (Rs 1.5 lakhs X 30.9 percent tax + cess).
The overall 80C cap for all eligible items, like employee provident fund (EPF) payments (deducted by your employer), PPF, life insurance premiums, NSC and ELSS mutual funds, and so on, is Rs 1.5 lakhs.
How to Save Long Term Capital Gain Tax
There are a few tried and true methods for reducing or eliminating the LTCG tax. To properly decrease liabilities, you must be well-versed in your portfolio and understand the net returns. Here are a few suggestions:
– Profits should be booked at the appropriate time.
You must be cautious here in order to determine how near you are to achieving a profit of Rs.1 lakh. Sell your stocks or mutual funds right before they generate an Rs.1 lakh profit and take your winnings. Your gain will be excluded from LTCG tax in this manner. There are no restrictions on repurchasing the same stocks and mutual funds after making a profit.
There are losses more often than not, which can occasionally be put to good advantage. To begin, the loss must be a long-term capital loss. Second, if there is a profit of more than Rs. 1 lakh on another mutual fund or share, the excess profit probably is offset by the loss, resulting in a net gain. This aids in the reduction or elimination of the tax burden. Here’s how to do it:
Suppose you have a profit on one investment of Rs. 1,40,000 [taxable profit is Rs. 40,000].
You now incur a loss of Rs. 20,000 on another investment [no tax liability].
If you compute the net gain (Rs. 40,000 – Rs. 20,000 = Rs. 20,000), you’ll see that you had to pay tax on Rs. 40,000 before, but now you only have to pay LTCG. Tax on Rs. 20,000, thus halving your tax due!
– Investing through relatives
In many homes, most of the family members do not invest in any financial products. As a result, if you may open Demat Accounts in their names and distribute your investment across several Accounts, each account would have a tax-free threshold of Rs.1 lakh. So, if you invest from four different Accounts, you effectively create an Rs.4 lakh exemption threshold.
It’s important to remember that long-term capital gains must be reported on your yearly income tax returns, or you risk receiving a letter from the IRS. If calculating LTCG on your investments in a financial year is proving problematic, seek expert assistance.
