• HDFC securities
• 27 Mar 2023
• Knowledge Centre

 

 

Investing in mutual funds is gaining traction among investors. If you are planning to invest in any type of mutual fund scheme, it is essential to know the taxes that are applicable to the profits or gains from mutual funds. The article offers a quick overview of Mutual Fund taxation. Read on.

How do Mutual Funds generate returns?

A mutual fund investment primarily earns you returns in two ways – dividend income and capital gains. The dividend is paid out by the companies in your portfolio out of their profits. Capital gains are the gains you realise when you redeem your mutual fund units at a higher value than you purchased them at.

Any type of income from mutual funds is taxable. Check out below the tax implications on mutual funds.

How is Mutual Fund dividend income taxed?

Dividend income is taxable at the hands of investors. Regarding tax implications on mutual funds, the entire dividend income is taxed according to the income tax bracket of the investor. It goes under the heading ‘Income from Other Sources.’

If the total dividend paid to an investor during a financial year exceeds Rs 5,000, the asset management companies deduct 10% TDS (tax deducted at source) from the dividend distributed. Investors can claim this 10% TDS at the time of payment of taxes.

How are Mutual Fund capital gains taxed?

Mutual fund capital gains attract Capital Gains Tax. There are two types of Capital Gains Tax – Short-term Capital Gains (STCG) and Long-Term Capital Gains (LTCG). Which type of Capital Gains Tax applies to you depends on your holding period. Following is a detailed explanation of how Mutual Fund Capital Gains are taxed:

Equity Oriented Funds

• Short-term Capital Gains – If your equity fund holding period is less than a year, STCG will be applied. Your gains will be taxed at a flat rate of 15%, irrespective of the income tax slab rate you classify under.

 

• Long-term Capital Gains – If your holding period is a year or more, LTCG will apply to you. Gains up to Rs 1,00,000 are tax-exempt. Gains above the given limit are taxed at 10%, without indexation.

 

ELSS

Equity Linked Savings Scheme (ELSS Mutual Funds) offer tax benefits as the amount invested in them is deductible up to Rs 1.5 lakh u/s 80C of the Income Tax Act. It follows a mandatory lock-in period of three years. Hence, typically LTCG tax applies to the capital gains earned on maturity.

Debt Funds

• Short-term capital gains – If your Debt Fund holding period is within 36 months, STCG applies to you. The gains are clubbed with your taxable income and taxed according to the tax slab you classify under.

 

• Long-term capital gains – If your holding period is more than 36 months, LTCG applies to you and the gains are taxed at a flat rate of 20%, after indexation.

 

Hybrid Funds

Mutual fund taxation on hybrid funds is entirely based on asset allocation. If the equity exposure is more than 65%, it is considered an equity-focused scheme and taxed like an equity fund. All other hybrid funds are debt-focused funds and taxation rules of debt funds apply to them.

Along with these, you also have to pay Securities Transaction Tax (STT) when you buy or sell mutual fund units of an equity fund or a hybrid equity-oriented fund. However, STT is not applicable to the sale of debt mutual fund units.

Taxation is a very important consideration as it directly impacts your returns. Holding mutual fund units for a longer time period makes the investment more tax-efficient. "To understand how your returns would grow, use tools like the SIP Calculator by HDFC SKY for accurate planning and projections. "