Mutual Funds Taxation in India- A Guide from Investor’s perspective

As the stock market is touching new highs, mutual funds are also gaining more and more attention from investors. In the last few years, mutual funds have yielded good returns to their investors which has resulted in a sharp rise in the interest of the public in the mutual funds. Mutual funds are considered as a good tax-saving instrument for the taxpayers also as they could get a tax deduction of up to Rs. 1,50,000 under section 80C by making investments in specified mutual fund schemes. Before making the investment in mutual funds, every investor would like to know the tax implications of returns derived from mutual fund investments. This article throws light on the tax provisions in respect of income derived from the mutual funds from the investor’s perspective.

A famous advertisement comes with a tagline “Mutual Funds Sahi hai” but before starting a discussion on this topic, we would certainly like to make a disclaimer that “Mutual Funds are always subject to market risk”.

What do investors get from mutual funds?

This is a silly question but surely, we would answer it as this is the core of this article. There is no doubt that every investor makes investments in mutual funds to get returns and get capital appreciation. But why mutual funds?? Certainly, the reason is that mutual funds have a team of people who are having in-depth knowledge of the stock markets. They have large funds at their disposal which they invest in quality stocks after making thorough studies. Mutual funds have better insights into market sentiments and economic scenarios as compared to the general investors. Therefore, the returns yielded by the mutual funds are far better than making direct investments in stocks.

The investor gets returns from mutual funds in two forms:

• Dividends
• Capital Gains on sale of mutual fund units (Short term/ Long Term)

Mutual funds accumulate funds received from a large number of investors and invest those funds in stocks to earn profits. Mutual funds may distribute such profits amongst their unitholders in the proportion to the units held by them. This is known as a “Dividend” which is taxable in the hands of the investors in India. We will discuss taxation issues of dividend income later in this article.

In addition to this, the investor can earn profits by selling the mutual fund units held by him at a NAV (net asset value) greater than his acquisition cost (purchase price). This profit is termed as “Capital Gains” which is also taxable in the hands of the investor deriving the profits. Capital Gains can again be classified as “Short Term Capital Gains” & “Long Term Capital Gains”. Such classification is made on the basis of the period for which investment is held by the investor in the mutual fund units.

Income tax on Dividend income from mutual fund units

• Any income in the form of dividends earned from mutual fund units is 100% taxable in the hands of the unitholder as per the slab rate applicable to him. Earlier, the Dividend was exempted in the hands of the unitholders as the companies were obliged to pay the Dividend Distribution Tax on the dividends distributed by them.
• But the Budget 2020 has changed the tax scenario and now dividend is a fully taxable income in the hands of the investors.
• Please keep in mind that while filing the Income Tax Return (ITR), you should disclose dividend income under the head “Income from Other Sources”.
• We would advise taxpayers to check their bank statements for the calculation of dividend income earned by them. You should also cross-check dividend income from the “Annual Information Statement” (AIS) available on the Income Tax Portal.

Taxation of capital gains on mutual fund units

Before understanding tax implications for capital gains on mutual fund units, we shall first discuss the term “Equity Oriented Funds” & “Debt Oriented Funds”. This will help us in analyzing tax provisions in a better manner.

How to ascertain whether capital gain is long term or short term for mutual fund units

The tax rate of capital gains of mutual funds depends on the holding period and the type of mutual fund. Holding period means the period for which the mutual fund units are held by an investor.

Note: It is important to ascertain whether capital gain is short-term or long-term as the tax rate varies in both cases.

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Income tax on capital gains for equity mutual funds

• As discussed above, Equity-oriented funds are those mutual funds where the portfolio’s equity exposure exceeds 65% of the overall portfolio. In the case of equity funds or hybrid equity-oriented funds, first, decide whether the holding period is 12 months or less.
• If the holding period is less than 12 months, the gain on sale of mutual fund units will be treated as “Short Term Capital Gains”.
• If the holding period is 12 months or more, the gain on sale of mutual fund units will be treated as “Long Term Capital Gains”.

**Applicable tax rates are subject to cess and surcharge.

Income tax on capital gains for debt-oriented funds

• As discussed above, Debt-oriented funds are those mutual funds where the portfolio’s debt exposure exceeds 65% of the overall portfolio. In the case of debt funds or hybrid debt-oriented funds, first, decide whether the holding period is 36 months or less.
• If the holding period is less than 36 months, the gain on sale of mutual fund units will be treated as “Short Term Capital Gains”.
• If the holding period is 36 months or more, the gain on sale of mutual fund units will be treated as “Long Term Capital Gains”.

**Applicable tax rates are subject to cess and surcharge.

Example:

Mr. Ram acquired 100 units of HDFC Debt Fund on 01-04-2017 at Rs. 25 per unit (Total Rs. 2,500). He sold all the units on 15-05-2021 at Rs. 48 per unit (Total Rs. 4,800). Cost Inflation Index: F.Y. 2017-18: 272; F.Y. 2021-22: 317. Compute capital gains.

Solution:

• Holding Period is 4 years & 1.5 months so capital gain derived is long term in nature.
• Cost of acquisition = Rs. 2,500
• Indexed Cost of acquisition = 2,500 * 317/272 = Rs. 2,914
• Long Term Capital Gain taxable @ 20% = 4,800 – 2,914 = Rs. 1,886.
• Tax on long term capital gain = 1,886 * 20% = Rs. 377 (subject to cess & surcharge)

To avail expert Income tax Return filing services call our expert at 09660930417 or click: Income Tax Return Filing services by Experts

Taxation of Capital Gains for Mutual Fund SIPs

Systematic Investment Plans (SIPs) are a unique way of investing in mutual funds where investors can invest a small amount periodically say monthly in a mutual fund scheme. Investors can choose the frequency of their investment at their choice either weekly, monthly, quarterly, half-yearly, or yearly. Since the investors purchase mutual fund units in intervals over a period of time, it becomes quite confusing for the investor to assess whether gains derived on the sale of mutual funds SIPs is short term or long term.

Here, the first thing which should be kept in mind is that the redemption of units is made on a first-in-first-out basis (FIFO). It means that the units purchased first are treated as sold first. Therefore, while ascertaining the holding period, the FIFO method should be followed. The units purchased through SIP and held for 12 months or more will be treated as “long term” and taxed accordingly [Refer tables above]. Similarly, the units purchased through SIP and held for less than 12 months will be treated as “short term” and taxed at the rate of 15% plus cess and applicable surcharge.

Read Related Articles:

Income tax on Dividend Income A.Y. 2021-22 and onwards

Short Term Capital Gains on Shares- An Investor's Perspective

Disclaimer: The above article is merely for educational purposes and has no persuasive value. Readers are requested to act diligently and under consultation with any professional before applying the information contained in this article.