Understanding Taxes On Mutual Funds

All mutual fund houses sell their mutual funds by showcasing the past performance of their mutual funds and the potential returns these schemes are expected to enjoy. However, nobody talks about the taxation aspect. It is important to understand the taxes on mutual funds as taxes and inflation can eat away a huge chunk of your sizeable returns. This article will act as a mutual fund investment guide and how they are taxed.

Understanding the types of taxes imposed on mutual fund investments

Mutual fund investments can offer returns to investors in two forms – either through capital appreciation or through dividend recipients. The taxation aspect on mutual fund investment is largely dependent on two factors – the types of mutual funds you choose to invest in (debt funds, equity funds, or hybrid funds) and the holding period of the investment. If you are unsure what a holding period of an investment is, do not worry, we will explain it out to you in layman terms. The holding period of the investment refers to the duration for which you stay invested in a particular mutual fund scheme. There are two types of holding period – short-term holding period and long-term holding period. Both equity and debt funds have different criteria that constitute a short-term holding period and a long-term holding period.

• Long-term holding period – Equity funds that are held for a period of 1 year or more are constituted as long-term investments. Contrary to that, debt funds that are held for a period of 3 years or more are constituted as long-term investments.
• Short-term holding period – Equity funds with a holding period of less than twelve months are considered asshort-term investments. On the other hand, debt investments that have a holding period of less than thirty-six months are considered as short-term investments.

Taxation on mutual fund investments

Capital earns refers to the profits earned on mutual fund investments which is possible when the sale of the mutual fund schemes is greater than the purchasing cost of the same. Depending on the holding period of the mutual fund investments, capital gains are further bifurcated into two types – long-term capital gains (LTCG) and short-term capital gains (STCG). Let’s have a look on these capital gains influence on the tax outgo on mutual fund schemes.

• Equity funds – STCG earned on equity funds are charged at 15% p.a. plus surcharge and cess, irrespective of the income tax bracket an investor belongs to. On the other hand, LTCG earned on equity funds are charged at 10% per plus cess and surcharge for gains exceeding Rs 1 lac.LTCG of up to Rs 1 lac on equity funds are exempt from any tax.
• Debt funds – STCG earned on debt funds are charged as per the income tax slab an investor belongs to. On the other hand, LTCG on debt mutual funds are taxed at 20% per annum plus cess and surcharge with the added benefit of indexation.
• Hybrid funds –Hybrid funds are taxed according to their asset allocation. For instance, if a hybrid fund allots 65% or more of their assets to equity funds, they would be taxed like equity mutual funds and vice versa.

Mutual Funds