Income Tax on Mutual Fund: Some mutual funds gives us deduction under section 80C of Income Tax Act, 1961. These are called tax saving mutual funds or ELSS (Equity Linked Saving Scheme). Investing in these funds can reduce our total income, however the maximum limit is Rs 1,50,000 and a lock in period of 3 years. While these funds save the amount of Income tax by investment but the returns and capital appreciation of these funds can be taxable.
Mutual Fund investor gains return from mutual fund either by way of capital appreciation or dividend/ interest receipts. If your mutual fund type is growth, the earnings from the fund are reinvested to increase the value of the fund at the time of redemption. When this fund is sold at profit (means at a value higher than at the time of purchase) then the gain is called capital gain.
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If your mutual fund type is “dividend” then the earning generated by fund are distributed periodically among its investors. While dividend upto Rs 10,00,000 is exempt in the hands of shareholders /unit holders, the tax calculation on sale of mutual fund can be complex.
Tax treatment depends on two factors:
- Type of Mutual Fund (Equity or Debt Funds)
- Holding Period
Type of Mutual Fund:
- Equity- oriented Funds– Any mutual fund with equity exposure of more than 65% are considered Equity-oriented Mutual Fund.
- Debt-oriented Funds– Any mutual fund with less than 65% equity exposures.
Holding Period:
| Types | Equity-oriented Fund | Debt-oriented Fund |
| Short-term Capital Gains (STCG) | Less than 1 year | Less than 36 months |
| Long-term Capital Gains (LTCG) | More than 1 year | More than 36 months |
Income tax on Mutual Fund Redemption
After understanding the period of holding we can differentiate capital gain into short term capital gain (STCG) or long term capital gain (LTCG).
Taxation for equity fund and debt fund differs based on their holding period. Let’s start with equity funds.
Capital gain is calculated by using this formula in equity funds-
| Capital Gain = Units Value (at the time of sale)– Cost of Sale (STT, brokerage,etc) – Cost of Acquistion of the units |
Once the capital gains are calculated on sale of mutual fund the liability can be calculated. For STCG 15% tax rate is applied, while for LTCG 10% tax rate is applied for LTCG exceeding Rs 1 lakh. Hence LTCG on equity fund up to Rs 1 lakh is tax-free.
In case of Debt funds capital gains are calculated using the same formulae but for LTCG on debt funds investors can take in effect on inflation and increase their cost of acquisition. It means Indexed Cost of Acquisition can be used by referring CII (Cost Inflation Index).
| Formulae for calculation Indexed Cost = Cost of Acquisition x (CII of the Sale Year/ CII of Purchase Year) |
This helps in reducing out gains and ultimately our tax liability.
After calculating the gains from sale of debt mutual fund tax is calculated. STCG becomes part of total income of investor and is taxable according to his income slab. However, LTCG on redemption of debt funds is taxed at the rate of 20%.
Read Also: SEBI New rules for Multi- Cap Mutual Funds
Income Tax on Mutual Fund SIP
Systematic investment plans (SIP) are a method of investing in mutual funds in which investors can invest a small amount periodically instead of deposition all amount in lump sum. Frequency of investment can be monthly, quarterly, bi-annually or annually.
Income Tax on Mutual Fund redemption in which amount was deposited in SIP is done in a way in which each SIP is treated as a fresh investment. The period of holding for each SIP will be different.
Conculsion
While we have tried to help you understand the taxation policies in case of redemption of mutual funds, one should not prevent himself or herself from investing in the mutual funds because of tax rates.
Mutual Funds still remains one of the top instrument in providing good return to capital with moderate risks. Portfolio investment and withdrawal can be managed in such a way as to exploit the benefits and exemption limits like LTCG on equity are exempt up to Rs 1 lakh.
Read Also: 8 High return Tax Saving Investment schemes
The author of the above article is Manav Khanna.
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