Contents
- Mutual Funds Holding Period
- Types of holding periods
- a. Long-term holding period
- b. Short-term holding period
- Holding period classification of mutual funds:
- Mutual Fund Taxation
- Tax-Saving Equity Funds
- Non-tax Saving Equity Funds
- Debt Funds
- Balanced funds
- Hybrid Mutual Fund Taxation
- SIPs
- Mutual Fund Dividends
- International Mutual Fund Taxation
- Conclusion
As banks provide lower rates of return on Fixed Deposits and savings accounts, mutual funds emerged as the best investment option for investors. In fact, the scope of mutual funds in India has now moved beyond just the larger cities and has now moved on to even the country’s smaller urban locations. Now, investors large and small are investing their hard-earned money into mutual funds. Hence it is common that more and more investors are asking questions regarding the tax implications of their investments. The present article will provide information on Mutual Fund Taxation.
Mutual Funds Holding Period
People invest to earn income on their investments in the form of interest, dividends or capital gains. And as they earn income, they need to pay income tax. The tax they need to pay on capital gains largely depends on the time for which they stay invested in the respective schemes. This is holding a period of mutual funds.
Types of holding periods
There are two types of holding period of mutual funds: Long-term holding period and Short-term holding period.
a. Long-term holding period
In the case of equity mutual funds and balanced mutual funds, a holding period of 12 months or more is regarded as long-term. So, long-term capital gains tax or LTCG regards to those investments. A holding period of 36 months or more is considered as long-term for debt funds.
b. Short-term holding period
A holding period of fewer than 36 months for debt funds and less than 12 months for equity and balanced funds are defined as short-term. Therefore, short-term capital gains tax concerns to income made from any scheme held for less than 36 months or 3 years. Some examples of short-term schemes include treasury bill, 91-day bonds, etc.
Holding period classification of mutual funds:
| Funds | Long-term | Short-term |
|---|---|---|
| Equity funds | 12 months and more | Less than 12 months |
| Debt funds | 36 months and more | Less than 36 months |
| Balanced funds | 12 months or more | Less than 12 months |
Mutual Fund Taxation
Tax-Saving Equity Funds
Equity-Linked Saving Scheme (ELSS) are the most valuable tax-saving investment under Section 80C. These diversified funds invest in equity shares of corporations across market capitalization.
ELSS comes up with a lock-in period of 3 years. This means you cannot redeem your units before the expiration of 3 years. After redemption, the long-term capital gains (LTCG) up to Rs 1 lakh are tax-free. LTCG above Rs 1 lakh is taxable at the rate of 10% without the advantage of indexation.
Non-tax Saving Equity Funds
Long-term capital gains (LTCG) on non-tax saving equity funds of up to Rs 1 lakh are tax-free. LTCG above Rs 1 lakh is taxable at the rate of 10% without the advantage of indexation. The government launched this in Budget 2018.
There is a 15% tax on short-term gains from equity funds if the units are redeemed before 12 months. There has been no alteration in the Budget 2018 in this respect.
Debt Funds
Long-term capital gains on debt fund are taxed at the rate of 20% after indexation. Indexation is a system of factoring in the increase in inflation between the year when the debt fund units were acquired and the year when they are sold.
Indexation permits inflating the purchase price of debt funds to take down the quantum of capital gains. You must add short-term gains from debt funds to your overall income. They are subject to short-term capital gains tax (SCGT) as per the income tax slab you fall under.
Balanced funds
Balanced funds are equity-oriented hybrid funds that invest at least 65% of their assets inequities. This is why their tax treatment is the same as non-tax saving equity funds.
Hybrid Mutual Fund Taxation
Hybrid mutual fund schemes have the legacy of investing in equity stock and equity-based instruments as well as debt and money market instruments. From a taxation view, the allocation of the hybrid fund’s assets is what’s essential. If the hybrid fund invests largely inequities, it is termed as an equity-oriented savings scheme. On the other hand, if the major investment of a hybrid fund is towards debt and money market schemes, the fund is concluded to be a debt-oriented hybrid fund. A hybrid fund characterized as an equity-oriented scheme, such as an arbitrage fund, is taxed as per the STCG and LTCG laws of equity investments. Likewise, a debt-oriented hybrid scheme such as a monthly income plan is taxable as per the taxation practices of debt investments.
SIPs
A SIP or a systematic investment plan is to invest a fixed amount in a mutual fund in a periodic way. A SIP can be daily, weekly, fortnightly, monthly or even quarterly. Gains from SIPs are taxable as per the type of mutual fund and the holding period. For taxation, each SIP is attended as a fresh investment and gains on it are taxed individually.
Mutual Fund Dividends
If you have invested in the dividend option of a mutual fund and received dividends from the scheme, those payouts are tax-free for you as per prevailing taxation laws. This holds for both debt and equity mutual fund dividends no matter how long you have been invested in the scheme. But, dividends payable by debt funds are subject to a tax termed as the dividend distribution tax or DDT. DDT is payable to the government not by the investor but by the fund house managing the mutual fund. In the case of most schemes, the DDT rate is around 30%.
International Mutual Fund Taxation
International mutual funds are schemes that invest in international equities of different companies. These funds are not classified as equity funds as they do not originally invest in domestic equities. Hence, Indian mutual funds primarily involved in making overseas equity investments are taxed as per the STCG and LTCG rules of debt mutual funds. The same taxation mechanism also holds for the Indian fund of funds that invest in international mutual funds.
Conclusion
Thus, the longer you hold onto your mutual fund units, the more tax-efficient they grow. This is because the tax on long-term gains is much lesser than the tax on short-term gains. Though exact details of which mutual fund tax rules will apply to a specific fund will, of course, depend on the composition of the fund itself. Thus obtain all the information of the applicable Mutual Fund taxation rules of your prospective investment before investing to avoid any confusion.
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