Investing in mutual funds is catching on more and more these days due to several reasons. To make the best of your mutual fund investment, it’s necessary to know one of the most crucial aspects of investing in any asset or security – taxation.
One of the reasons for the immense popularity of mutual funds includes the various tax-saving provisions, depending on which type you invest in. Here, we will discuss how these different types of mutual funds are taxed so that you can devise your investment strategy accordingly. After all, the way each instrument in your portfolio is taxed can significantly impact your overall cash flow.
How mutual funds’ returns are classified
The taxation scheme on your mutual funds will depend on the form of returns you are earning. There are two common forms of returns: dividends and capital gains.
The company distributes dividends to their fund holders out of the profits they earn or when there is surplus cash. Your dividends will be paid out such that they are proportional to the number of fund units you hold.
Capital gains are as simple as the selling price of your securities surpassing the purchase price. This happens as a result of market fluctuations.
How mutual funds’ dividends are taxed
According to the Union Budget 2020, dividends are considered a part of your income and taxed as per the applicable income tax slab. Fund houses are obligated to pay a dividend distribution tax (DDT) on the dividends they declare at the end of a financial year.
As of 2021, equity schemes that allocate 65% or a greater part of the investment capital in equities and equity-related securities have to pay 10% DDT in addition to a 12% surcharge and 4% cess. This brings the total effective DDT to 11.64% for every investor.
How mutual funds’ capital gains are taxed
The profits you earn by selling off your mutual fund units are known as capital gains. Taxation on these gains depends on whether you have invested in equity or non-equity schemes, as well as how long your investment tenure before selling is. Equity investments held for less than one year are called ‘short-term capital gains’ (STCG) and taxed at 15%, whereas those held for more than a year are called ‘long-term capital gains’ (LTCG) and taxed at 20% if the total returns in a year exceed Rs. 1 lakh.
However, if you invest in non-equity instruments like debt mutual funds or others, taxation differs. In this case, holdings with a tenure of 3 years or less are deemed STCG and taxed at 20%. Those held for over 3 years are deemed LTCG and taxed at the highest tax slab that applies to your annual income.
Bear in mind that some equity-oriented mutual funds provide you with tax exemptions up to Rs. 1.5 lakhs, thanks to Section 80C of the Income Tax Act of 1961. For example, ELSS mutual funds.
If you plan to start investing in mutual funds, you can download the Tata Capital Moneyfy App, compare the performance and ratings of different funds, and take another step towards fulfilling your financial goals.