Mutual Funds are generally thought to be the most tax-friendly investment option. However, most people are unaware that mutual fund gains are taxed based on certain rules.
The key factor for determining the Taxation of Mutual Funds in India:
1. Types of Mutual Funds: For taxation, mutual funds are classified into two categories: equity and debt-oriented mutual funds.
2. The type of gains generated (capital gains or dividend): Capital gains are the gains you generate when you sell a capital asset for a higher price than its cost, while a dividend is a part of profits accumulated that the mutual fund house distributes to the investors of the scheme (i.e., dividends don’t require an investor to sell the asset). A discussion on what these are and how each of these is taxed follows in a subsequent section.
3. Your holding period: The holding period dictates the rate of tax you’ll pay on your capital gains. The greater your holding period, the less tax you’ll pay. India’s income tax regulations encourage a longer holding period, which is why holding your investment for longer reduces your tax liability.
Tax implications of dividends:
The Finance Act, 2020 introduced an amendment withdrawing the Dividend Distribution Tax. Dividend income from mutual funds was tax-free for investors before March 31, 2020. The fund houses that declared dividends deducted a Dividend Distribution Tax (DDT) before paying it to the mutual fund investors. Now, the entire dividend income is taxable in the hands of the investor as per the income tax slab under the head “income from other sources.”
TDS (tax deducted at source) is also applicable to the dividend distributed by the mutual fund scheme. As per the changed rules now, when the mutual fund distributes the dividend to its investors, the AMC must deduct 10% TDS u/s 194K if the total dividend paid to an investor exceeds ₹5,000 during a financial year. When you pay your taxes, you can claim the 10% TDS that has already been deducted by the AMC and only pay the balance.
Taxation on Capital Gain:
The tax on mutual funds capital gains depends on the types of mutual fund scheme you are invested in and how long have you held the units of the scheme for.
1. Short Term Capital Gain(STCG) Tax:
An individual makes short-term capital gains when he or she sells the mutual fund investments after holding them for less than 12 months. These gains can be gained on both equity and debt mutual funds.
2. Long Term Capital Gain(LTCG) Tax:
An individual makes long-term capital gain when he or she sells the mutual fund investments after holding them for more than twelve months. These gains can be gained on both equity and debt mutual funds.
Taxation based on investor Tax status:
