If you are a mutual fund investor or someone planning to invest, staying aware of how your returns from mutual funds will be taxed is essential. Profits or gains from mutual funds are taxable, just like most of the other asset classes you invest in. As taxes are difficult to avoid, it will be good to know about the tax on mutual fund rules before you start investing. Apart from this, understanding mutual funds taxation can help you plan your investments to minimize your overall tax outgo; this article will walk you through all elements of mutual funds taxation.

How mutual funds investments are taxed

Investing in mutual funds is as good as investing in the underlying security itself. So, the taxation aspect of each scheme depends upon the asset classes in which the scheme invests. Like any other investment, it is important to consider the tax implications of mutual fund investments before making them.

Depends on the type of scheme

For taxation purposes, mutual fund schemes can be categorised into two main types—equity-oriented schemes and non-equity-oriented schemes. The former are those that invest at least 65% and above of their net assets in shares of listed Indian companies. Schemes that invest less than 65% or don’t invest in equity are non-equity schemes, such as liquid funds, debt funds, gold funds, etc. Both types are taxed differently.

Taxation on Capital Gain

The tax on mutual funds capital gains depends on the types of mutual fund scheme you are invested in and how long have you held the units of the scheme for. Based on the Let us understand the two factors in detail.

First, let’s talk about the terms long-term capital gains (LTCG) and short-term capital gains (STCG) and what they mean. LTCG is the capital gain generated from an asset that an investor holds for a long duration (i.e., a long holding period), while STCG is the capital gain generated on assets held for a relatively shorter duration.

The terms long and short duration differ for equity and debt schemes for tax purposes. For instance, for capital gain on mutual funds to be treated as long term, your holding period must be at least 12 months for equity-oriented schemes, but 36 months for debt-oriented schemes. The following table gives an overview of the holding periods required for capital gains to be treated as long term and short term.

Capital gain

The gain made from the sale of the security is termed as capital gain. If the security is held for a short term, the gain is short-term capital gain (less than one year in the case of equity schemes and less than three years in the case of non-equity schemes).

Equity funds

Gains from equity funds redeemed within one year are taxed at 15%. If the same is redeemed after one year, the gains over Rs.1 lakh are taxed at 10%.

Non-equity funds

If these are redeemed within three years, the gains are added to the income and taxed as per the applicable income tax slab. However, if non-equity funds are redeemed after three years, the gains are taxed at 20% with an indexation benefit.

Dividend income

Dividends received on mutual funds are taxed at the respective income tax slab rate. Dividends received in excess of Rs 5,000 are subject to tax deduction at source (TDS) at 10%.

Points to note

As international funds invest in shares of foreign companies, they are taxed as non-equity-oriented schemes.
Securities transaction tax (STT) is also applicable at 0.001% on redemption from equity funds, irrespective of the holding period.