Mutual funds are generally considered as one of the most fruitful investment options as it plays a crucial role in achieving your financial goals easily. One of the greatest advantages of investing MFs is they are also tax-efficient investment instruments. Investment in a mutual fund can reward you with tax-efficient returns.
If you are planning to invest in mutual funds, you might be making a mistake without considering tax. The reason is that it will affect your cash flow. In addition to taxation, an investor should also check on factors such as taxation on dividends, redemption, etc.
In this blog, we seek to discuss how taxation may impact the returns from mutual funds.
Before we delve deeper into the taxation angle, let us discuss the sources of income from mutual funds.
Income from mutual funds can be either from –
Let us discuss dividends first.
Dividends received from funds are exempted from tax. A DDT of 25% is levied on non-equity-oriented schemes along with a 12% surcharge and 4%cess, making an effective DDT amounting to 29.12% for both resident Indians and NRIs.
Before understanding the taxation structure on capital gains, we need to understand capital gains from the point of the mutual fund holding period.
Since capital gains are taxed by income tax authorities, the quantum of tax to be paid depends on the holding period. The holding period can be classified into two broad categories – Short-term and long-term.
The following table gives an idea of what constitutes short-term and long-term
|Equity||< 12 months||> = 12 months|
|Balanced||< 12 months||> = 12 months|
|Debt||< 36 months||> = 36 months|
1.Tax saving equity funds
2. Non-tax saving equity funds
Long Term Capital Gain (LTCG) Tax on redemption is exempted up to Rs. 1 lakh. If LTCG is more than 1 lakh, the applicable tax is 10% without indexation.
Short-term capital gains are taxed @ 15%
2. Balance fund
They are equity-oriented funds that invest 65% (minimum) of assets in equities. These are taxed as, “Non-tax savings equity funds”.
3. Systematic Investment Plan (SIP)
Each investment is considered a new venture and capital gains are taxed accordingly.
The following example will help to understand tax:
One investor invests Rs 5,000 per month starting from April 2020
Another investor invests Rs 60,000 lump sum at the same time
Both redeem their entire funds.
In the case of a SIP investor, Rs 5,000 will qualify for tax exemption as the investment made in April 2020 would have exceeded more than 1 year as of May 2021
In the case of an investor who invests Rs 60,000 lump sum in April 2020, the entire capital gain is exempted.
Disclaimer: The views expressed in this post are that of the author and not those of Groww.