Tax implications of income gained from investing in mutual funds
Capital gains are the profits earned by investors on their mutual fund investments when they sell the mutual fund units
Investors today have too many choices when it comes to picking up mutual funds (MFs). This also implies that investors are holding an excessive number of investments in mutual funds (MF). That said, MFs also come with a tax advantage when it comes to taxes savings mutual funds as one derives tax-efficient returns. This is why investors must understand the tax implications of income gained from investing in mutual funds. Capital gains are the profits earned by investors on their mutual fund investments when they sell the mutual fund units.
That being stated, capital gains can be classified as either Short-Term Capital Gains (STCG) or Long-Term Capital Gains (LTCG) (LTCG). This is dependent on the ‘Period of Holding’ of the mutual fund units, which is measured from the date of purchase to the date of sale. The tax on these profits is referred to as ‘Capital Gains Tax.’
Equity Mutual Fund
The ‘Capital Gains Tax’ is determined by various factors, including the fund’s type and holding period. Equities mutual funds are those that invest at least 65% of their assets in equity. The selling of equity mutual fund units is classified falls under LTCG or STCG, depending on the holding duration of the units.
So, if units of listed equities mutual funds are held for at least 12 months before sale, the gains generated are long-term capital gains. If units of listed equity mutual funds
The short-term capital gains would be taxed at the rate of 15%. Whereas long-term capital gains are taxed at 10%, provided such gains exceed the threshold limit of Rs. 1 lakh in a financial year. The LTCG derived up to Rs 1 Lakh enjoy tax exemption.
Debt Mutual Fund
Non-equity mutual funds (Debt Funds) invest in less than 65% of their assets in equity. Similar to how equity mutual funds are taxed, debt mutual funds are taxed differently depending on whether the units are long-term or short-term in nature.
However, in this scenario, profits are classified as STCG if the units are sold before 36 months; otherwise, gains are classified as LTCG if the units are sold after 36 months. Short-term capital gains are taxed at the investor’s marginal slab rate, whereas long-term capital gains on debt funds are taxed at 20% with indexation. Also, one is also levied with applicable cess and surcharge on tax.
The indexation process accounts for inflation between the time the taxpayer purchased the asset and the time he sells it. Indexation increases the cost of acquisition of the asset; hence it lowers capital gains.
Taxation of mutual fund dividends
Dividends paid by any mutual fund scheme are taxed under the amendments introduced in the Union Budget 2020. Investors’ dividends are added to their taxable income and taxed at their individual income tax slab rates.
Dividends were previously tax-free in the hands of investors since companies paid dividend distribution tax (DDT) before sharing their profits with investors via dividends.