When you invest in mutual funds, you consider various points
like expected returns, goals, time horizon, etc. but unfortunately most
investors do not take into consideration tax implication of their mutual funds.
It is important to do so since they affect the overall returns and other decisions like the structure of your portfolio and the timing of your exit.
How are mutual funds
taxed?
Mutual funds are taxed based on the asset classes they
invest in.
There is one set of rules for equity mutual funds and
another for debt mutual funds.
For the purpose of taxation, international mutual funds are
considered as debt mutual funds.
Equity mutual funds
An equity mutual fund is a fund that invests primarily in
shares of companies.
Since equity mutual funds carry the most risk among all
mutual funds, they also have the potential to generate the highest returns.
For a fund to qualify as an equity mutual fund, it needs to
invest 65% of its corpus in equities at all times.
Only tax saving mutual funds, also known as elss funds need
to invest 80% of its corpus in equities at all times as opposed to 65% for
other equity mutual funds.
LTCG
Long term capital gains tax better known as LTCG is applied
on equity mutual funds when the gains from equity mutual funds held for more
than a year are more than 1 lakh.
The LTCG rate is 10%.
Capital gains up to 1 lakh are exempt for taxes.
There is no indexation benefit when calculating LTCG.
STCG
Short term capital gains tax better known as STCG is applied
on gains from equity mutual funds which are held for 12 months or less.
The STCG rate is 15%.
There is no ceiling benefit in STCG like the 1 lakh ceiling
in LTCG.
STCG is charged on from Re 1.
Hybrid Mutual Funds
Hybrid mutual funds are a mixture of equity, debt, cash,
etc.
Any mutual fund scheme in the hybrid mutual fund category
that holds 65% into equity will be treated as an equity mutual fund and will be
taxed as one.
Examples include Equity savings fund and aggressive hybrid
funds.
Funds that do not hold a minimum of 65% into equity will not
be treated as an equity fund and therefore will not be taxed as one.
Example includes any conservative hybrid fund.
For multi asset mutual funds the taxation rules differ from
scheme to scheme, this is because some schemes hold 65% into equities and some
do not.
The ones who do not are taxed as debt mutual funds.
Tax Saving/ELSS Mutual Funds
Tax saving/elss mutual funds allows you an exemption of up
to 1,50,000 in your taxes under section 80c of the income tax act.
Tax saving funds have a lock in period of 3 years.
Elss funds need to invest a minimum of 80% of its overall
portfolio into equities.
In case of sip plans, you have to keep in mind that each sip
instalment completes 3 years in case you wish to redeem.
Are elss mutual funds also taxed?
Yes, elss mutual funds better known as tax saving mutual
funds are also taxed as any other equity mutual fund.
They can only be charged LTCG since they have a lock in
period of 3 years so therefore by default the holding period is more than a
year.
Elss mutual funds allow you tax exemptions but the gains on
them is not tax free.
Additional reading: Click Here to read our complete report on ELSS funds and how they work
Debt mutual funds
Debt mutual funds invest in government securities,
debentures, corporate bonds, etc. unlike equity mutual funds which invests
primarily in equity and equity related instruments.
They provide lower returns than equity mutual funds but more
safety.
They are less volatile than equity mutual funds and are more
suited for short term goals.
LTCG
For debt mutual funds, long term capital gains tax is
applied on gains from debt mutual funds held for more than 36 months.
The LTCG rate for debt mutual funds is 20% after indexation.
STCG
For debt mutual funds, short term capital gains tax is
applied on gains from debt mutual funds held for less than 36 months.
Short term capital gains are added to your income and taxed
as per your income tax slab.
Taxation on SIP investments
SIP in mutual funds is a process by which you invest systematically
a fixed amount in mutual funds either daily, weekly, monthly, quarterly,
bi-annually or annually.
The taxation on sip mutual funds is more complicated and not
as straight forward as compared to lumpsum investments in mutual funds.
Each SIP instalment is considered as a fresh investment and
therefore each sip instalment is taxed accordingly.
Suppose you invest 5,000 on a monthly basis for 15 months
after which you redeem the entire amount (invested amount + profits).
After 15 months if you stop and redeem the entire amount
(invested amount + profits) only the profits of the first three months would be
tax free since they have completed a year and not crossed 1 lakh in profits
whereas the rest of the instalments would be charged STCG.
What is Indexation?
Indexation is a procedure by which the purchase price of an
asset is adjusted according to inflation.
Therefore, indexation increases the purchase price of an
asset.
This reduces the overall gains and in turn the taxes to be
paid as well.
Taxes on International mutual
funds
International mutual funds are taxed as debt mutual funds.
The taxation rules applicable on debt mutual funds are
applicable on international mutual funds too.
It is the same for all international mutual funds
irrespective of the geography.
Meaning a US based international mutual fund will be taxed
in the same manner as a European, emerging markets or Asia based.
Securities Transaction Tax
An STT of 0.001% is charged by the government on the sale of
equity mutual funds and equity-oriented hybrid funds.
There is no STT charged on the sale of debt mutual funds.
Stamp Duty
From July 1, 2020 onwards a stamp duty of 0.005% is deducted
on the investment amount of mutual funds for any transaction executed on or
after July 1 2020.
This is applicable on:
- Purchases
- Dividend Reinvestments
- Systematic Investment Plan (Inclusive of running SIP’s registered earlier)
- Systematic Transfer Plan
- Equity as well as Debt schemes
A simple illustration to understand this better
Application Amount: 1,00,000
Stamp Duty: 0.005%
Stamp Duty Amount: 1,00,000 X 0.005% =Rs 5
Net Investment Amount (After deducting Stamp Duty) =
9,99,995
As can be seen by the above illustration, if you have a long
term horizon then there’s not much to lose sleep over.
Tax on
dividend received from Mutual Funds
Dividend Distribution Tax (DDT) has been abolished for
mutual funds from 1st April 2020 as announced in the budget for
2020.
Earlier dividend received from mutual funds was tax free in
the hands of the investor since tax for the same was already paid by the mutual
fund in the form of Dividend Distribution Tax (DDT).
Due to this the dividend was received by an investor but the tax was
paid by the mutual fund company.
With a fixed Dividend Distribution Tax rate, small and big
investors alike ended up paying the same tax rate irrespective of the dividend
amount.
Under the new rule now, effective 1st April 2020
onwards, dividend received from mutual funds is now added to investors income
and gets taxed according to the investors tax bracket.
For example lets say Mr A received dividend Rs 10,000 on 25th
August 2020 which is more than 5,000, he will pay a TDS of Rs 750 on the
dividend income.
7.5% of 10,000 is 750, therefore he would receive Rs 9,250
which would then further be added to his taxable income for the financial year.
The standard rate for TDS on dividend income exceeding 5,000
is 10%, however the government has reduced that to 7.5% from 14 May 2020 to 31
March 2021 in light of Covid-19 crisis.
For portfolio enquiries, email us with your doubts at info@themutualfundguide.com
