Know About Tax on Mutual Funds in India

In India, the investment in mutual funds is one of the most efficient and common ways to build wealth. But an understanding of mutual fund taxation is necessary to invest wisely. This article aims to shed light on mutual fund taxation in India, the hows and whys, along with some common queries like how is a mutual fund taxed, tax on mutual fund returns, and tax on mutual fund profit.

Types of Mutual Funds and Their Taxation

1. Equity Mutual Funds

Equity mutual funds have a certain minimum portfolio allocation toward equity of 65% of the total portfolio.
With respect to equity mutual funds, the taxation depends on the holding period:

• STCG : A 15% tax on mutual fund returns if you sell your units before a year.

• LTCG : If the units are sold after one year, any LTCG above ₹1 lakh in any financial year will be subject to 10% tax without indexation.

• Dividends : The investor gives tax on the basis of his or her income tax slab; on a dividend exceeding ₹5,000 in a financial year, a 10% TDS will be applicable.

2. Debt Mutual Funds

Since 1st April 2023:

• All Short-Term Capital Gains (STCG) shall be taxed as per the income tax slab of the investor irrespective of how long one has held the same.

• LTCG benefit by way of indexation will no longer be available.

Up to March 31, 2023, debt mutual funds were taxed in India as follows:

• STCG (holding period ≤3 years): Taxed as per the income tax slab of the taxpayer.

• LTCG (holding period >3 years): Taxed at 20% with an indexation benefit.

• Dividends: Taxed at slab rate plus 10% TDS on the amount (if it exceeds ₹5,000) during the year.

Effective from April 1, 2023, the indexation facility was withdrawn from any gain accrued and all debt mutual fund-related gains were subjected to the tax level of the investor slab, irrespective of the holding period.

3. Hybrid (Balanced) Funds

Taxation for Hybrid funds (or Balanced Mutual Funds) in India depends upon the equity-debt mix.

• If an equity fund comprises 65% or more equity, it is considered so, and it is taxed on short-term gains (up to 1 year) at 15% and long-term gains (beyond 1 year) at 10% above ₹1 lakh.

• A fund with less than 65% in equities is treated, per Indian tax rules, as a debt fund.

• Short-term gains (up to 3 years) are taxable according to the investor's tax slab, and long-term gains (after 3 years) are taxed at 20% with indexation benefit.

• Dividends are taxed per the slab rates of the investor; TDS is applied at 10% if dividends are above ₹5,000.

Taxation Based on Holding Period

The tax on mutual fund returns varies depending on how long you hold the investment:

Tax on dividend from Mutual Funds

Before, dividends were tax-free in the hands of investors as mutual funds paid a Dividend Distribution Tax (DDT). But from April 1, 2020, dividends are added to the investor's income and taxed according to the income tax slab for mutual funds.

Companies must deduct 10% TDS on dividends exceeding ₹5,000 in a financial year.

For example, Mr. X receives a ₹6,000 dividend. Since this crosses the ₹5,000 limit, ₹600 (10%) is deducted as TDS, and he gets ₹5,400 in hand.

But that’s not all - the full ₹6,000 is still taxable as per Mr. X’s applicable income tax slab for the year.

Taxation of International Funds of Funds

Mutual funds that invest in international equities or other mutual fund schemes are taxed differently.

From April 1, 2023, gains from investments made will be charged to the income slab of the taxpayer. Investments made prior to April 2023 would enjoy long-term capital gains that would be liable to tax at 20% with indexation if the units are sold before July 23, 2024, assuming that the units have been held for at least 36 months. Long-term capital gains will be taxed at 12.5% if sold after July 23, 2024, assuming that the units were held for at least 24 months.

How Much Tax on Mutual Funds?

The amount of tax on mutual funds in India depends on:

• Type of mutual fund (equity or debt).

• Holding period (short-term or long-term).

• Investor’s income tax slab.

Case 1: Equity Fund (Holding for 2 Years, Profit ₹2 lakh)

• LTCG on ₹1 lakh is tax-free.

• Remaining ₹1 lakh taxed at 10%.

• Total Tax: ₹10,000.

Case 2: Debt Fund (Holding for 2 Years, Profit ₹2 lakh, Tax Slab 30%)

• No LTCG benefit.

• Entire ₹2 lakh taxed at 30%.

• Total Tax: ₹60,000.

Declaration of Mutual Fund Investments in ITR

Disclosing all mutual fund investments and the gains or losses incurred during a financial year is a must when filing the income tax returns.
You must submit information including:

• Name of the fund

• Date of purchase and sale

• The Purchase price

• The Sale price

The capital gains statement is provided by most fund houses, which gives a short-term and long-term gains figure for the financial year in an automatic manner. This statement can work as a reference for you when filing your ITR.
If you have capital gains from mutual funds, you'll need to file either ITR-2 (for salaried individuals) or ITR-3 (for those with business income).

Ways to Reduce Tax on Mutual Fund Investments

• Opt for ELSS Funds : You can claim up to ₹1.5 lakh deduction under Section 80C.

• Hold Investments for the Long Term : Holding equity funds for over a year reduces tax liability.

• Use Tax Harvesting : Sell units to book gains within ₹1 lakh annually to avoid LTCG tax.

• Choose Growth Over Dividend Option : Growth options help defer taxation until withdrawal.

Conclusion

There is no doubt that the knowledge of tax on mutual funds can help increase effective return and plan taxes in a way that allows maximum rebates. An equity mutual fund enjoys long-term capital gains tax exemption, while a debt mutual fund is taxed based on the slab rate of the investor when the investor falls under it. Based on the goal, the investment should be done along with the tax-saving planning.