Are investments into mutual funds tax-free? What are tax advantages?
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Mutual funds involves pooling money of several investors and investing in various securities. Buying a mutual fund is like buying a small slice of a big pie. The owner/ investor of a mutual fund unit gets a share proportionate to the fund’s gains, losses, income and expenses.
Mutual funds can be of 2 types-
1. Equity Mutual Funds
2. Debt Mutual Funds
Equity Linked Savings Scheme (ELSS) is a type of Equity Mutual fund which offers its owner tax benefits.
Various tax benefits of mutual funds are as follows-
Dividend received on mutual funds is tax exempt-
Investors need not pay any tax on the dividend received from the mutual funds. Further, there is no maximum limit to the amount which can be claimed as tax exempt under this heading.
Capital Gains tax benefit from mutual funds-
Value of a mutual fund is measured by Net Asset Value or NAV. Value of a mutual fund can either increase or decrease, corresponding to the change in value of the constituent security in the particular mutual fund. According to the Income Tax Act, 1961 capital gains arising from sale of the mutual fund (underlying security) can be categorized into-
1. Long term capital gains
2. Short term capital gains
On Debt funds-
Gains on debt funds held for a period greater than 36 months is known as Long Term Capital Gains (LTCG) is subject to a rate of 20% after indexation. Indexation makes use of inflation to help reduce tax to be paid.
If the debt funds are held for a period of less than 36 months, then such gains are added to the assessee’s income and taxed under the head ‘Short term Capital Gain’ as per the income tax slab of the assessee.
On Equity funds-
Gains on equity funds held for a period greater than 12 months is known as Long Term Capital Gains (LTCG) which are totally tax- exempt.
If the debt funds are held for a period of less than 12 months, then such gains are taxed under the head ‘Short term Capital Gain’ at a flat rate of 15%.
On ELSS-
An ELSS holder can claim deduction of the amount invested in the scheme under section 80C of the Income Tax Act, 1961. The maximum amount of deduction that can be availed under the above mentioned act is Rs. 1,50,000 for a particular assessment year (AY). However, the amount invested in ELSS should not be withdrawn for a period of minimum 3 years, which is often referred to as lock-in period.
Capital gains treatment for ELSS is same as that for Equity funds.
Additionally, a tax saving mutual fund can be identified by carefully looking at the name of the mutual fund. Keywords such as tax saver, tax shield or tax fund help to serve the purpose. A few tax saving mutual funds are-
1. DSP Blackrock Tax Saver Fund
2. Birla Sun Life Tax Relief 96
3. IDFC Tax Advantage Fund
Mutual funds can be tax-efficient investment avenues that can help reduce your tax burden and at the same time increase your wealth. But not all investments into mutual funds are tax-free under Indian Income Tax Act.
Tax benefits:
1. Section 80C Tax benefit of investing in Equity mutual funds:
Tax Planning or Income tax savings are an integral part of investment and overall financial planning that helps in a bid to maximize wealth. Tax planning in India involves the selection of the right tax saving instruments and making proper investments. One of the key sections under which individuals can save tax is the Section 80/C of the Indian Income Tax Act. Under this section, investments up to 1,50,000 per annum are eligible for deduction from your taxable income.
Only ELSS Mutual Funds offer tax benefits under section 80C of the Income Tax Act. As per this section, one can avail tax exemptions up to INR 1,50,000 by investing in ELSS funds.
Introduction to Equity Linked Savings Scheme (ELSS)
ELSS is a dedicated mutual fund scheme that allows investors to save tax. It also provides an opportunity for long term capital appreciation. An ELSS fund manager invests in a diversified portfolio, predominantly consisting of equity and equity related instruments that carry high-risk and have the potential to deliver high-returns.
Features of ELSS Funds
1. Tax-saving
2. Three-year lock-in period
3. Can be held even after the completion of three years
4. Offers dividend as well as growth options
5. Tax Saving instrument
2. Lock-in period of Equity Mutual Funds:
The lock-in period of equity mutual funds which are allowed to be claimed as a deduction under Section 80C is 3 years. In other words, these mutual funds cannot be sold before 3 years.
The lock in period of Equity Mutual Funds is the least when compared with the 5-year lock-in period of the other popular tax saving instruments like PPF Account, National Savings certificate, Tax Saving Fixed deposit.
3. Tax Exemption on Dividend paid on Mutual funds:
The mutual funds regularly pay out dividends to its investors. The dividend received by the investors from these mutual funds is tax free in the hands of the investors.
4. Capital Gains Tax on the sale of Mutual Funds:
If you sell your equity mutual funds after a year, the returns will qualify for long-term capital gains tax. Long-term capital gains tax is nil on equity. If you sell your equity mutual funds before a year, you will have to pay short-term capital gains tax of 15 per cent on your returns.