If  you are planning to make an investment in mutual funds, without taking tax in into consideration, you are making a mistake.

Why?

Because it will affect your cash flow.

In addition to taxation, an investor should also check on factors such as taxation on dividend, 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 –

  • Regular dividend
  • Sale of shares in funds

Let us discuss dividends first.

Dividends received from funds are exempted from tax. While the fund house pays Dividend Distribution Tax (DDT) of 28.84% for mutual funds.

Capital gain tax on mutual funds

Before understanding the taxation structure on capital gains, we need to understand capital gains from the point of 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.

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

Funds Short-term Long-term
Equity  < 12 months  > = 12 months
Balanced  < 12 months  > = 12 months
Debt  < 36 months  > = 36 months

Taxation

a) Long-term capital gains

1.Tax saving equity funds

An investment made under ELSS (Equity Linked Savings Schemes) qualifies for tax exemption under section 80C. The total savings under 80C that qualifies exemption is Rs.1.5 lakhs (max).

Apart from ELSS, other payments like LIC, PF, Children school fees etc also qualify.

If an investor has no other deduction in 80C, he can invest a maximum of Rs.1.5 lakhs to qualify for tax exemption. If the investor is in the 20% tax bracket, he saves Rs.30000 tax.

If the investor claims Rs.50,000 exemption on payment of children school fees, PF etc, he can invest Rs.1 lakhs in ELSS. The maximum permissible exemption under 80C is Rs.1.5 lakhs

ELSS comes with a locking period of 3 years. The investor can’t redeem the units before 3 years.

Long Term Capital Gain (LTCG) Tax on redemption is exempted up to Rs.1 lakh. If LTCG is more than 1 lakhs, the applicable tax is 10% without indexation

Some of the ELSS funds worth investing are detailed here.

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.

Check out Groww recommended Large-cap , Mid-cap and Small-cap funds.

b) Short-term capital gains

Short-term capital gains are taxed @ 15%

1.Debt funds

Long-term capital gains (=>36 months) on debt funds are taxed at 20% after indexation. (Indexation takes into consideration the inflation between the year of purchase of debts funds and the year of sale of debt funds)

Short-term capital gains (< 36 months) on debts funds are added to your income and taxed as per the applicable slab your  income falls under (5% or 20% or 30%)

Check out Groww recommended debt funds here.

2.Balance fund

They are an equity oriented fund that invest 65% (minimum) of assets in equities. These are taxed as, “Non-tax savings equity funds”.

Some of the balanced funds worth investing are detailed here.

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 2017

Another investor invests Rs 60,000 lump sum in April 2017

Both redeem their entire funds.

In case of an SIP investor, Rs 5,000 will qualify for tax exemption as the investment made in April 2017 would have exceeded more than 1 month as on May 2018

In case of an investor who invests Rs 60,000 lump sum in April 2017, the entire capital gain is exempted.

Should you wish to know from taxation perspective how you should invest, feel free to connect with us.

Happy Investing!

Disclaimer: The views expressed in this post are that of the author and not those of Groww