Mutual Funds are an investment instrument where funds are mustered from different sources to purchase securities. These sources can be financial institutions, companies, and individuals. Foreign investors can also invest in this market.
These funds generate income in the form of – dividends and capital gains.
The dividend is generated and disbursed periodically to the investor as long as the Mutual Funds belong to him/her.
Capital gains, on the other hand, are received when the investor decides the sell the fund. This gain arises out of the difference between the cost of acquisition and selling price. Prices of securities either appreciate or depreciate over a period. Depending on the case, an entity might make capital gains or losses.
These gains are bifurcated into two types – long-term capital gain and short-term capital gain on Mutual Funds.
The classification of gains originates from the holding period of the sold security. It represents the length of time for which an entity owned a particular fund. It varies across different mutual Funds for short-term and long-term capital gain.
The different kinds of Mutual Funds are –
Listed equity funds – This type of Mutual Funds are used to purchase shares and stocks of various companies listed under recognised stock exchanges such as NSE or BSE. These funds generate a higher rate of return; however, the risk factor is also high in these cases.
It is because returns heavily depend on cyclical market fluctuations. Equity funds qualify as short-term capital assets if they are redeemed or sold before 12 months or 1 year from the date of acquiring it. Any profit from such sale is considered as STCG on Mutual Funds.
Debt funds – These funds are invested towards purchasing of debt instruments from the stock market or otherwise. Incomes from these funds are steady as issuer companies are bound to disburse dividend periodically and entail a lower risk factor. However, the yield is lower compared to equity funds.
Gains from the sale of debt funds are considered short-term capital gain on Mutual Funds if the sale takes place within 36 months or 3 years of acquiring it. Examples of debt funds are bonds, 91-day treasury bills, debentures, etc.
Equity–oriented hybrid funds – These funds have a mix of both shares and debentures. However, in the case of equity-oriented hybrid funds, 65% or more of the investment goes toward shares and stocks. Therefore, the holding period for it to qualify as a short-term capital asset is 12 months.
These mutual Funds for short-term capital gains are a healthy investment option as individuals can exploit both the high-yield factor of equity funds and lower-risk factor of debt funds.
The following table demonstrates the holding period for Mutual Funds
|Particulars||Short-term capital gain||Long-term capital gain|
|Listed equity funds||<12 months||>12 months|
|Debt funds||<36 months||>36 months|
|Equity-oriented hybrid funds||<12 months||>12 months|
|Debt-oriented balanced funds||<36 months||>36 months|
|Unlisted equity funds||<36 months||>36 months|
Taxation on short-term capital gains is required to be paid from two ends – investor’s end and fund house’s end. Fund houses are organisations that act as fund managers for entities and have professionals with understanding in cyclical market fluctuations.
These organisations bear the responsibility to pay Dividend Distribution Tax on behalf of the investor.
The tax which is paid from the investor’s end follows the standard tax regime.
Taxation varies across all the different fund types and their holding period. In the case of short-term capital gain on Mutual Funds, the tax discipline maintained is as follows –
Suppose Mr Anil, who is 45 years of age, earns Rs 25000 as a short-term capital gain for the year 2019. His total income for the year amounts to Rs 1200000.
The income amount attracts a 30% tax. Therefore, he is liable to pay a 30% tax on Rs 25000, which is Rs 7500.
The following table illustrates the applicable tax rate of short-term capital gain on Mutual Funds
|Equity funds||15% u/s 111A|
|Debt funds||As per the individual’s slab rate (5%-30%)|
|Equity-oriented hybrid funds||15% u/s 111A|
|Debt-oriented balanced funds||As per the individual’s slab rate (5%-30%)|
|Balanced funds||15% u/s 111A|
|Unlisted equity funds||As per the individual’s slab rate (5%-30%)|
In case a security is sold at a price lower than its cost of acquisition due to depreciation, it is considered as a short-term capital loss.
Short-term capital losses are set off against short-term capital gain on Mutual Funds, STCG on other investments, and long-term capital gains. In case the entire amount of short-term capital loss can’t be set off in a single year, it can be carried forward to the subsequent year. These losses can be carried forward for eight consecutive years.
Short-term capital gain on Mutual Funds is less tax efficient compared to long-term capital gains. Finance Ministry is also considering exempting tax on LTCG on securities after a security has been held for more than 3 years.
Related Mutual Fund Pages
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