Mutual Funds are financial instruments that collect capital from various investors and pool them to invest in the purchase of company shares, bonds, stocks. These Mutual Fund investments are shared by thousands of individuals and are managed by professional fund managers under asset management companies to earn maximum returns. The Mutual Fund portfolios are maintained and structured according to their investment objective communicated to investors.
Earnings from Mutual Funds can be classified into two categories –
Capital gain from Mutual Funds refers to the profit that is acquired by individuals on the sale or transfer of the asset. On the other hand, the income generated when the underlying assets in Mutual Funds pay interest or earnings is known as a dividend.
For the purposes of taxation, capital gains on Mutual Funds are taxed at the hands of investors while the tax on Mutual Funds dividends, known as Dividends Distribution Funds (DDT) is levied on fund houses on behalf of investors.
Now, the capital gains acquired from the transfer of various types of Mutual Funds can be classified into long term and short term gains depending on the holding period of the funds. Short term capital gain tax on Mutual Funds is levied on those funds with a holding period of fewer than 12 months (36 months in some cases).
However, to understand the tax implications on Mutual Funds, it is crucial to understand the different types of Mutual Funds and the capital gains generated from them.
Capital gain from Mutual Funds refers to the difference between the purchase price of a Mutual Funds unit and the value at which it is sold. An individual can choose to invest in different types of Mutual Funds, like, equity funds, debt funds, and hybrid funds.
If the holding period of any of these funds is less than 12 months (36 months in some cases), then the gain from the transfer of these funds is known as the short term capital gain from Mutual Funds.
The taxability of short term capital gain on Mutual Funds is different for equity, debt, and hybrid funds. Following is a detailed analysis of each of these funds and tax implications on each of them.
Equity Mutual Funds are those that principally invest in the shares and stocks of various companies. These generally yield higher returns than other Mutual Funds through share investment in companies of various market capitalisations.
Now, the short term capital gains from the transfer of equity-oriented Mutual Funds can be divided into two categories for the purpose of taxation. These are –
The following table illustrates the tax on short term capital gain on Mutual Funds for equity-oriented funds –
|Equity oriented funds sold under any recognised stock exchange and liable for STT charges||15%|
|Any other equity-oriented Mutual Funds||Included during the investor’s income tax return filing and taxed according to his/her income tax slab|
Debt funds, in general, invest in securities like government securities, corporate bonds, commercial paper, treasury bills, etc. which generate fixed interest. Unlike equity-oriented funds, an individual primarily invests in these funds to earn interest income. In the case of debt-oriented funds, short term capital gain is earned on the transfer or sale of any fund with a holding period of 36 months or less.
The gains from debt funds are not taxed under Section 111A of the Income Tax Act. They are liable for taxation as per the income slab of individuals.
Investors choosing to invest in hybrid Mutual Funds do so to attain maximum diversity in their investment portfolio. These Mutual Funds invest in a mixture of equity and debt-oriented instruments to achieve maximum returns. The short term hybrid funds are usually utilised to generate income while the long term ones are for wealth appreciation.
Investors can choose to invest in several types of hybrid funds. For instance – equity-oriented hybrid funds, debt-oriented balanced funds, balanced funds, etc. The gains from each of these funds are taxed according to their respective orientation and holding periods.
The table below illustrates the types of hybrid funds, their holding periods, and their subsequent tax liabilities –
|Type of hybrid fund||Holding period for short term capital gains||Tax liability|
|Equity oriented hybrid fund (where 65% or more of the fund’s assets are invested in equity instruments)||12 months or less||15%|
|Debt oriented balanced funds (where 60% or more of the fund’s asset allocation is in debt instruments)||36 months or less||Taxed as per the investor’s income tax slab|
|Balanced funds (where 65% of the portfolio is invested in various equity and equity-oriented schemes)||12 months or less||15%|
Hybrid funds also include investments in monthly income plans, arbitrage funds, etc.
Apart from the above-mentioned income tax on short term capital gain on Mutual Funds, Equity Mutual Funds are also liable for STT or Securities Transaction Tax.
This is a kind of tax that is collected at the source and levied on every equity-oriented fund that purchases or sells securities listed under recognised stock exchanges in India. For the sale of a unit of equity-oriented Mutual Funds, there is a 0.001% STT levied on the investor.
Learning these tax implications is crucial for any individual looking to invest in short term Mutual Funds. In case investors incur a capital loss from investing in any of these short-term assets, the loss can either be set off against other capital gains or carried forward for a period of up to 8 assessment years.
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