Mutual Funds and Taxation: Key Considerations for Investors in 2023

Feb 13th 2024
Mutual Fund
Mutual Funds and Taxation: Essential Guide for Savvy Investors

Investing the right amount of money at the right time paves the way for a secure future at least in regard to money. And, when it comes to choosing the most profitable avenues for money investment, mutual funds emerge at the top these days. There are several points that make mutual fund investment the best one at present – easy investing, the option to track growth, a wide range of funds to choose from, low-cost investment, and most importantly tax savings. There are several types of funds that allow investors to save on income tax under section 80 C. 

Be it a long-term investment or a shorter one, mutual funds provide a plethora of options to meet the diverse investment needs of people. But there is another aspect related to taxation on mutual funds that not many investors pay attention to. The profits accumulated through mutual fund investment are subjected to tax and for a sagacious investor, it is necessary to pay focus on the same. In this post, we will strive to find out the relationship between mutual funds and taxation. 

Note: According to the Budget 2023, No indexation benefit would be applicable while measuring long-term capital gains on a Specified Mutual Fund (i.e. a mutual fund that invests less than 35% of its proceeds in the equity shares of domestic companies). Debt mutual funds will now be taxed as per the applicable bracket rates.

How Mutual Funds Are Taxed?

Profits accumulated through mutual funds investment in mutual funds can be held liable for taxation in the form of ‘Capital gains’. Therefore, before you invest in mutual funds, do ensure that how your profits would levy tax. In addition, one can also get tax deductions in some scenarios.

Factors That Determine Tax on Mutual Funds

There are several factors that are known to affect the applicable tax on mutual funds investment. They are defined below:

  •  Type of Fund: Taxes are charged essentially on debt-based and equity-based mutual funds.
  •  Dividend: It refers to a section of the profit dispersed amongst investors by mutual fund companies. 
  •  Capital gains: When investors trade their capital possessions at an upper price in comparison to total investment value, the profit is called capital gains.
  •  Investor’s holding period: It refers to the time between the buying and selling date sale of units set under a mutual fund. According to the latest income tax guidelines, if one holds an investment for a large period of time, he will be subjected to a lower tax amount. Hence, the holding period makes an effect on the tax rate applicable on the accumulated profits. The prolonged the holding time, the lower will be your tax burden.

How Much Return Mutual Fund Gives?

There are two ways to get returns from Mutual funds - dividends and capital gains. Dividends are simply a part of the profits made by the business if any. When they have excess cash, they can choose to share it with investors as dividends. Investors basically get dividends given the quantity of units available to them in mutual fund units.

A capital gain refers to the profit gained by investors if the units held by them get a higher price than their purchase price. In other words, capital gains are made due to the increase in the price of the fund units. Both the dividends and the capital gains levy some taxes on investors.

Tax on Dividends

According to the recent changes done in the Budget 2020, dividends provided by a mutual fund house are taxed classically. It means that the dividends gained by investors can be attached to their chargeable income and taxed at their applicable income tax bracket.

Earlier, there was no tax on dividends as the companies were subjected to pay dividend distribution tax (DDT) before releasing the dividends.

Tax on Capital Gains

The tax levied on the capital gains of mutual funds relies mainly on the holding timeframe and fund type. Capital gains are measured on the sale of mutual funds and are categorized as follows:

Type of Fund

Short-term Gains

Long-term Gains

Equity

Lesser than 1 year

1 year and more

Debt

Always short-term

 

Hybrid Equity-oriented

Lesser than 1 year

1 year and more

Hybrid Debt-oriented

Always short-term

 

Tax on Capital Gains for Equity Funds

Equity funds refer to funds where greater than 65% of the total invested amount is put in the equity stocks of businesses. An investor gets short-term capital gains if he redeems his equity fund units within 12 months. These gains levy tax at a standard rate of 15%, regardless of the income tax slab.

One tends to develop long-term capital gains by selling his equity fund units after keeping them for at least a year. Capital gains of up to Rs. 1 lakh a year levy zero tax. Any long-term capital gains beyond this range levy LTCG tax at 10%, without indexation advantage.

Taxation of Capital Gains of Debt Funds

Debt funds are funds whose debt exposure is more than 65% and equity exposure is less than 35% of the total fund value. As per the latest report, the debt funds wouldn’t attract indexation benefits and are believed to be short-term capital gain. Thus, the gains from debt funds will be attached to the investor’s taxable income and the respective taxes will be levied. 

Taxation of Capital Gains of Hybrid Fund

The tax rate of capital gains on hybrid or balanced funds mainly rests on the equity revelation of the portfolio. If the exposure is more than 65%, the fund would levy tax like an equity fund, if not the tax structure of debt funds would become applicable.

 

Hence, it is necessary for investors to understand the equity exposure of the hybrid scheme they are supposed to invest. Here is a table that summarizes the tax rate of capital gains on mutual funds.

Type of Fund

Short-term Gains

Long-term Gains

Equity
Hybrid Equity-oriented

15%+cess + surcharge

Any gains more than Rs 1 lakh is taxed at 10% + cess + surcharge

Debt
Hybrid Debt-oriented

Respective income tax slab rate of the investor

Respective income tax slab rate of the investor

 

Securities Transaction Tax (STT)

Along with the applicable tax on dividends and capital gains, another applicable tax is the Securities Transaction Tax (STT). A 0.001% STT is charged by the government (Ministry of Finance) when an investor chooses to buy or sell his units of either an equity fund or a hybrid equity-oriented mutual fund. There is zero tax applicable on the trade of debt fund units.

The Conclusion

So, from the above points, you would be in a better position to determine the applicable taxes on the returns delivered by mutual funds in Delhi. Want to know more about mutual funds? Talk to a team of experts at Investkraft, which is a leading financial services company. Choose from a plethora of mutual funds to buy and make big gains.

 

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