Taxation of Mutual Fund Gains in India

Mutual funds have become popular investment solutions for people looking to build long-term wealth. Investors must understand the Taxation of Mutual Fund to optimise returns and conform with the Income Tax Act, of 1961. This article deals with Taxation on Mutual Funds in India, with a focus on income tax rules. 

Contents

Tax on Mutual Funds

Tax on mutual funds means the amount of tax that investors need to pay on the income evolved from their investment in mutual funds. The tax rate depends on the type of mutual fund and its period held. Capital gains taxes are given when investors sell their mutual fund units. It needs to be understood that the tax implications of investing in mutual funds are essential in planning one’s investment strategies.

Capital Gains Tax

Capital gains tax is levied on the profits realized from the sale or redemption of mutual fund units. It applies to both equity and debt funds, albeit with different tax rates and holding period requirements.

Equity Mutual Funds

Equity mutual funds are those with a minimum of 65% investment in equity shares. The capital gains tax on equity funds is classified into two categories:

• Short-term Capital Gains (STCG): For equity funds held for a period of up to one year, any gains arising from their redemption are classified as STCG. Currently, the applicable tax rate for STCG on equity funds is 15%, as per Section 111A of the Income Tax Act.

• Long-term Capital Gains (LTCG): If equity mutual fund units are held for more than one year, the resulting gains are considered LTCG. Starting from April 1, 2018, the Finance Act introduced a tax on LTCG exceeding INR 1 lakh per financial year. As per Section 112A, LTCG on equity mutual funds is taxed at a rate of 10%.

Also, read: How to set up A Mutual Fund Business in India?

Debt Mutual Funds

Debt funds predominantly invest in fixed-income instruments such as government securities, corporate bonds, and debentures. The taxation of gains from debt mutual funds depends on the holding period:

• Short-term Capital Gains (STCG): If debt mutual fund units are held for a period of up to three years, the resulting gains are classified as STCG. These gains are taxed as per the investor’s tax slab, aligning with the applicable income tax rates.

• Long-term Capital Gains (LTCG): For debt funds held for more than three years, the gains obtained are considered LTCG. As per Section 112 of the Income Tax Act, the tax rate on LTCG from debt mutual funds is 20% (with indexation benefits), or 10% (without indexation benefits).

DDT (Dividend Distribution Tax)

Based on the profits made by their investments, mutual funds may pay out dividends to appropriate investors. In those scenarios, dividend distribution tax is given to the respective mutual fund company rather than the investors. Dividend distribution tax rates vary based on the type of mutual fund:

• Equity-oriented funds: Dividend Distribution Tax is not applicable, thanks to the introduction of the Dividend Distribution Tax (DDT) amendment by the Finance Act 2020.

• Non-equity funds (debt funds): Dividend Distribution Tax is imposed at a rate of 28.84%, including surcharge and cess.

Winding Up Note

In India, the tax on mutual fund gains depends on various factors such as the holding period and the type of fund. Short-term gains from debt funds are added to the individual’s income and taxed at their applicable slab rate. However, long-term gains from equity funds are taxed at a flat rate of 10% without indexation or 20% with indexation, whichever is lower. Thus, the investors should ensure compliance with tax laws and maximize profits and are recommended to work with tax professionals and financial advisors.

In case of any query regarding Taxation on Mutual Funds in India , feel free to connect with our legal experts at Legal Window at 72407-51000.