Mutual funds in India are ideal investment options for wealth creation as well as saving for all your financial goals. But if you are an investor in these, you should be very clear about how these mutual funds are taxed in India.
So in this article, let’s have an in-depth look at the latest Rules of Mutual Fund Taxation and also on the various aspects of the taxation of investments in different types of mutual funds.
The Mutual Funds provide earnings/gains in 2 ways. First is by means of Capital Gains. And other is via Dividend payouts. Let’s see how both of these are taxed as per the latest rules of mutual fund taxation in India:
Mutual Fund Capital Gains Taxation (Latest Rates)
Any profit that is made from mutual fund investments (or from SIP in mutual funds) is referred to as Capital Gains. Mathematically, capital gains is the difference between the price at which you buy the units of a mutual fund scheme and the price at which you sell them.
So for example, if you invest Rs 5.0 lac in an equity fund on 15th August 2017 and after 2 years, when you sell, the value you get is Rs 6.5 lac – then the capital gains is Rs 1.5 lac.
Now how much is this capital gains taxed depends on the type of mutual fund and the holding period (or investment tenure).
Depending on your investment horizon (or holding period), the capital gains are of 2 types:
- Short Term Capital Gains (STCG) or
- Long Term Capital Gains (LTCG)
What are these and how is long term and short term decided?
Long Term Capital Gains
- Gains on investment in Equity Mutual Funds held for more than 1 year (or 12 months) is classified as Long Term Capital Gains.
- Gains on investment in Debt Mutual Funds held for more than 3 years (or 36 months) is classified as Long Term Capital Gains.
Short Term Capital Gains
- Gains on investment in Equity Mutual Funds held for less than 1 year (or 12 months) is classified as Short Term Capital Gains.
- Gains on investment in Debt Mutual Funds held for less than 3 years (or 36 months) is classified as Short Term Capital Gains.
As for which mutual fund schemes are treated as equity funds and which as debt funds, is clearly defined as follows:
- Mutual Fund schemes that invest at least 65% of their portfolio in equity and equity-related instruments are treated as Equity Funds For Examples: Large-cap, Mid Cap, Multi-Cap, Small Cap, ELSS tax saving funds, Aggressive Hybrid Funds, Sector or Thematic funds, etc.
- Mutual Fund schemes that invest less than 65% of their portfolio in equity and related instruments are treated as Debt funds (or Non-Equity Funds). For Example: Liquid funds, Ultra Short Duration Funds, Short Duration Funds, Low Duration funds, Money Market funds, Conservative Hybrid funds, etc. (you can read more about debt funds categories)
So how exactly are these long-term capital gains and short-term capital gains taxed for equity and debt funds?
As per the latest Mutual Funds Capital Gains Taxation Rules (2019-2020):
- The Short Term Capital Gains (or STCG) on equity funds is taxed at 15%.
- The Long Term Capital Gains (or LTCG) on equity funds is taxed at 10% on LTCG exceeding Rs 1 Lac.
- The Short Term Capital Gains (or STCG) on Debt funds is taxed as per the investor’s income tax slab rate.
- The Long Term Capital Gains (or LTCG) on Debt funds is taxed at 20% (with indexation* benefits)
* – Indexation is a way to adjust your capital gains as per the prevailing inflation index. This helps lower overall liability to pay taxes by inflating the purchase cost, thereby reducing the effective capital gains. The advantage of indexation in mutual funds is available only for long term capital gains made on debt funds.
So that is how tax rates on capital gains differ for equity funds and debt funds. And generally, the short term capital gains attract a higher tax rate as compared to long term capital gains.
Note – Earlier, LTCG on Equity was Nil. But from 1st April 2018, any Long Term Capital Gains made on Equity Funds will be taxed at 10% on the long-term gains above Rs 1 lac per annum. For example, if your long-term capital gain in equity funds in a financial year is Rs 1.5 lac, then only Rs 50,000 will be taxable as LTCG.
So how is capital gains from SIP taxed?
Each SIP instalment is considered as a new investment. Hence, each SIP instalment will have its own unique holding period for the calculation of whether the gains are STCG or LTCG.
So each SIP you do is treated as a new investment and attracts taxes on its gains separately.
With regards to the introduction of the long-term capital gains tax (LTCG) on equity and equity-oriented mutual funds, there is another aspect of taxation. I told that you will have to pay a 10% tax on long-term capital gains from equity above Rs 1 lac a year. But all your long term capital gains (LTCG) made till January 31, 2018, however, remains grandfathered, i.e., gains will remains tax-exempt. For this, you will need mutual fund NAVs on 31 January 2018.
To read in detail how this tax calculation on LTCG and grandfathering of capital gains exactly work out, you can read the detailed analysis about the Impact of LTCG on Long Term Equity Investors. You may also like to read about the 3 big changes for all mutual fund investors.
Let’s move on and for the time being, stick to taxes on mutual funds.
So let’s take a few simple examples to understand the LTCG and STCG taxation calculations for equity and debt funds:
- STCG (Equity Funds) Calculations – Suppose you invested Rs 1000 in an Equity MF scheme on 1st January 2018. Now the value of this investment became Rs 1200 on 10th August 2018. If you exit now, then you are exiting equity fund in less than a year. And your capital gain becomes short-term capital gains. So the STCG of Rs 200 (Rs 1200 – Rs 1000) will be taxed at 15%.
- LTCG (Equity Funds) Calculations – Suppose you invested Rs 1000 in an Equity MF scheme on 1st January 2018. The value of this investment became Rs 1700 on 10th August 2020. If you exit, then you are exiting equity fund in more than a year. And your capital gain becomes long-term capital gains. So the LTCG of Rs 700 (Rs 1700 – Rs 1000) will be taxed at 10%. (But only if overall LTCG for the investor in the year is more than Rs 1 lac as mentioned earlier too)
- STCG (Debt Funds) Calculations – Suppose you invested Rs 1000 in a Debt MF scheme on 1st January 2018. Now the value of this investment became Rs 1150 on 10th August 2019. If you exit now, then you are exiting debt fund in less than three years. And your capital gain becomes short-term capital gains. So the STCG of Rs 150 (Rs 1150 – Rs 1000) will be taxed at your income tax slab rate.
- LTCG (Debt Funds) Calculations – Suppose you invested Rs 1000 in a Debt MF scheme on 1st January 2018. Now the value of this investment became Rs 1300 on 10th August 2021. If you exit now, then you are exiting debt fund in more than three years. And your capital gain becomes long-term capital gains. So your LTCG from debt funds are eligible for indexation benefit. Suppose the CII in 2018 was 144 and in 2021, it was 176. So the purchase price for tax purposes will be adjusted to raised to (176/144)*1000 = 1222. So the taxable gain will be 1300 – 1222 = 78 (and not 1300 – 1000). So the tax payable will be 20% of 78 = Rs 15.6 and not Rs. 60 (20% of Rs 300).
By the way, remember that stock markets do not go up in straight line.
And it is not just about capital gains in mutual funds.
At times, even losses occur. Right?
Remember ‘Mutual fund investments are subject to market risks…’? 😉
So what happens to those capital losses in mutual funds? They can come in handy if you know what to do. And here is what you should no – The short-term capital losses can be adjusted against both long term and short-term capital gains. But the long-term capital losses can only be adjusted against the long-term capital gains.
And that is all there is to know about the latest Mutual Funds Capital Gains taxation rules in India.
Now let’s look at the taxation of Mutual Fund Dividends. It’s pretty simple.
Mutual Fund Dividends Taxation (Latest Rates)
Dividend Distribution Tax (or DDT) is deducted and paid by fund houses before they pay the dividends to investors. So dividends at the hand of investors is tax-free. And how much is the DDT being paid? The rates are different for equity and debt funds:
- Tax on Dividends from Equity Funds: Fund houses pay 10% Dividend Distribution Tax or DDT (which becomes about 11.64% inclusive of 12% surcharge & 4% cess) on equity mutual fund schemes
- Tax on Dividends from Debt Funds: Fund houses pay 25% Dividend Distribution Tax or DDT (which becomes about 29.12% inclusive of 12% surcharge & 4% cess) on debt mutual fund schemes
And that is all about the taxation of dividends received from different mutual funds. It is tax-free in the hands of investors but AMC already deducts DDT before paying the dividends, which reduces the in-hand return for investors.
After such a ‘taxing’ discussion about mutual funds, let’s see how you can save some taxes through mutual funds.
Yes, you heard it right.
The answer to the question Can you save taxes through mutual funds? …is Yes you can.
As you already know about it, ELSS (Equity Linked Savings Scheme) funds offer a tax advantage to investors. Investing in these closed-ended tax-saving ELSS funds make you eligible to avail deduction of up to Rs 1.5 lac every year under the Section 80C of Income Tax Act.
These ELSS funds, which are often compared with PPF vs ELSS, give inflation-beating returns as per historical data. But have a lock-in period of 3 years. And at the time of redemption (after minimum lock-in of 3 years), if capital gains from ELSS fund (that is long term capital gains on equity) is more than Rs 1 lac, then LTCG will be applicable at 10% without indexation. If the amount is less than or equal to 1L, then you are not liable to pay any LTCG.
So that covers the various aspects of the taxation of mutual funds in India.
And let me remind you something here – Mutual funds have created immense wealth in past is proven by so many SIP success stories in India. And that is in spite of taxation, etc.
So the taxation on capital gains on mutual funds should not stop you from investing in mutual funds and getting good returns in the long run. When it comes to mutual funds and their taxation, here are some things to keep in mind:
- Before picking any mutual fund to invest, understand the goal you are saving for and whether the mutual fund is suitable for the goal or not. In this way, you will be in a better position to stay invested in the fund throughout the investment horizon without having to exit in an unplanned manner which can attract unnecessary tax liabilities. If you cannot find good mutual funds to invest in and which are suitable for your needs, go ahead and consult a fee-only financial adviser.
- Don’t try to trade in mutual funds. And refrain from frequent purchase and redemption of funds. This will only increase your taxes.
- Some more tips for new mutual fund investors.
- When it comes to picking mutual funds, do not try to be too adventurous and go for the hot new fund every year. Instead, try to pick simple and good mutual funds which are also best for your portfolio and do not require you to enter/exit them every year. And that is the reason why even rebalancing of the portfolio (i.e. moving part of the portfolio from debt to equity or vice-versa) should be done only after considering the tax implications. So less churn you do (by selecting the right mutual funds), better it is for you from taxation of capital gains perspective.
I hope this detailed post (Tax Reckoner for Investments in Mutual Fund Schemes in India 2019 2020) answered all your questions about Mutual fund taxation and latest income tax rules on gains from Mutual Funds in India.