If you are a mutual fund investor or planning to be one, then it would be wise to know the taxation of Mutual Funds so you may plan your investments and withdrawals accordingly. Tax rules get reviewed every financial year, so it becomes necessary to remain updated with the latest rules to plan your finances well.
Taxation of mutual funds essentially depends upon three parameters:
1. Type of fund you are in (Equity / Non-Equity): From the taxation point of view, mutual funds are broadly divided into two categories- Equity Funds and Non-Equity Funds.
Equity funds are those funds, in which the exposure to Equity and related instruments is 65% and above.
All other funds, which do not satisfy the above condition, are Non-Equity Funds, which means all categories of debt funds, hybrid funds with less than 65% exposure to equity, Gold Funds, even the International equity Funds, etc, all come under this category.
2. The Holding Period of your Investments (Long term / Short Term): Besides the type of fund, holding period also plays a major role in determining the taxation of mutual funds. It can be either short-term or long-term.
- In the case of Equity Funds, if the holding period or duration of investments is less than 12 months, it is termed as short-term and when it is more than 12 months, it is termed as Long-term.
- In the case of Non-Equity Funds, if the holding period or duration of investments is less than 36 months, it is termed as short-term and when it is more than 36 months, it is termed as Long-term.
3. Your Tax Residential Status: Your tax residential status also impacts the taxation of Mutual Funds. Tax Rules are slightly different for Resident Indians and NRIs. (Read: Who is an NRI? As per Income Tax & FEMA Rules)
Taxation of Mutual Funds- Equity Funds:
Mutual funds taxes come under Capital gains taxation.
In case of Equity Funds, if the holding period is less than 1 year i.e. they are sold within 12 months of purchase, gains on the same are short-term capital gains (STCG) are taxed at the rate of 15%.
And when the holding period is more than 1 year, gains are taxed at the rate of 10%, without any indexation benefit. However, gains up to Rs. 1 lakh would be tax-free per financial year. NRIs are also eligible for this 1 lakh Exemption benefit.
No TDS would be deducted in the case of Capital Gains earned by Resident individuals, but in case of NRIs, TDS rates would be the same as tax rates i.e. 15% and 10% as the case may be. So, if the taxable income of NRIs is below the threshold limit, then they may claim for a Tax Refund by filing ITR on time. (Also Read: Benefits of filing ITR on time)
Rest all taxation rules are the same for Both Residents and Non-Residents in case of Equity Funds.
The below table summarizes tax provisions for Equity Funds:
Important points to consider:
- In case of SIP, every individual installment would be treated as a new investment and long term capital gains would apply only when each of the installments has completed 12 months individually.
For example, you start a SIP of Rs. 10,000 in XYZ Equity Fund. After 12 months, you wish to redeem the corpus, only the gains from the first installment would be treated as a Long term, the rest would be treated short-term and taxed accordingly.
(Read: What is SIP in mutual funds?)
- Apart from this, an additional tax of 0.001% on equity funds is also levied by the Ministry of Finance in the name of Securities Transaction Tax (STT).
Taxation of Mutual Funds- Non-Equity Funds:
In case of Non- Equity Funds, If the holding period is short-term (i.e. holding period less than 36 months), the gains out of the same are called as Short-term capital gains (STCG) and are added to the income of the individual and taxed as per the income tax slab, in case of both Residents and NRIs.
However, a TDS @ 30% is applicable in the case of NRIs on short-term capital gains. But if this is the only income that NRI has and the total amount of gain is less than the basic exemption limit i.e. Rs 2.50 lakh currently, then NRI may claim the TDS Refund by filing ITR.
When the holding period is more than 3 years, gains would be treated as Long-term capital gains (LTCG) and are taxed at the rate of 20%, with indexation. (Read: How to do the Indexation in Mutual funds?)
Here is a slight change in case of NRIs. NRIs are not allowed any indexation benefit on unlisted debt Mutual funds and their capital gain tax rate is 10%. In case of Listed Mutual funds, the tax is 20% with indexation, Like in case of FMPs or any other close-ended debt fund with 3y+ maturity
Also, TDS @ 20% is applicable for NRIs in case of LTCG.
The below table summarizes tax provisions for Non-Equity Funds:
Taxation of Mutual Funds- Dividends:
The tax rules on the Dividend payments of Mutual Funds have changed recently.
From FY 2020-21, dividends paid by Mutual Funds, whether on Equity or Non-Equity funds, in short-term or long- term, would be taxable in the hands of the investor. The dividend would be added to the total income of the investor and would be taxed as per the applicable income tax slab rates.
For instance, the one falling in the 30% slab, you will pay tax at that rate and the one falling in the 5% slab, will pay tax at that rate.
Previously, Government used to levy Dividend Distribution Tax (DDT) on mutual fund houses, which was 11.65%, including surcharge and cess, for equity funds and 29.12%, including surcharge and cess, for non-equity funds and the dividend received by the investor was net of taxes (tax-free), which is now abolished.
Mutual Fund houses also have to deduct TDS at the rate of 10% on the dividends paid in excess of Rs. 5,000 per year.
In case of NRIs, both the TDS and tax rate is 20%. However, this rate can be even lower if the provisions of DTAA is availed. This is due to the fact that the tax treaties with most of the countries limit the taxation on dividends between 5% to 15%.
Advance-tax liability on dividend income shall arise only after the declaration/payment of dividend.
The taxation rules remain the same in Dividend payout as well as the Dividend reinvestment option.
In the end-
As written in the beginning, that tax rules get tweaked yearly and may impact your investments too. Though I will try to update the article with the latest rules, but still before taking any investment decision referring to the tax rules written here, do consult your CA or a Financial Planner. Or ask in the comments section below for verification
Hope, the write up clears all your doubts on taxation of mutual funds in India, if you have any questions, feel free to ask in the comments section. Also, if you find it useful, do share it with your family and friends.
This Post on Taxation Of Mutual funds in India 2020, is written by Mr. Varun Baid