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Taxation of Mutual Fund

Taxation of Mutual Fund

In the recent years, mutual funds have become the most favored instrument of investment for salaried class and professionals in India. Many individuals invest through Systematic Investment Plans (SIPs). As on 31st August 2018, the total number of SIP accounts in India stood at 2.4 crores.The mutual funds are broadly classified into two types:Equity oriented mutual funds, for taxation purpose, are those which invest more than 65% of their corpus into equities.

  • Arbitrage mutual funds, which invest in arbitrage opportunities in cash and derivative segments of the equity markets, are treated as equity funds for tax purpose.

The Debt oriented funds are those other than equity-oriented funds.

  • For income tax purposes, international funds (which invest in stocks abroad) and fund of funds (a mutual fund scheme that invest in different mutual funds) are considered as debt funds.

There are two prominent sources of income from mutual funds

  1. Gains or profit on redemption of mutual funds, and

  2. Dividend received from mutual funds

The taxability of these returns/incomes is discussed in respect of the two kinds of funds as below

Equity oriented mutual funds

  1. If you redeem your equity fund investments within a year, the returns or gains are treated as short-term capital gains and taxed at 15% of such gains or returns or profits.

  2. On the other hand, if you hold the mutual funds for more than a year before redemption, then the gains or returns are treated as long term capital gains and you have to pay a 10% tax on the amount of gains exceeding Rs 1 lakh a year on equity investments. There is no tax if your gains on such redemptions are less than or equal to Rs. 100,000/-.

  3. In respect of mutual fund investments done before 31/01/2018, the gains therein will be exempt from tax (grandfathering effect).

  4. Dividends from equity mutual funds are tax-free in the investor’s hands. However, this dividend is distributed by the Fund House (AMC) after paying dividend distribution tax (DDT). Therefore, the effective dividend for the investor is reduced by 11.64% (including surcharge and cess). This reduces the effective return on mutual funds in the hands of investors.

Debt Oriented Funds

  1. In case of debt funds or non-equity funds, if you hold your investments for a period of lesser than 3 years, the gains on redemption are treated as short-term capital gains for taxation purpose. Short-term capital gains are added to your income and taxed according to your applicable income tax slab.

  2. If the holding period of debt fund investments is more than three years, returns are considered as long-term capital gains for taxation purpose and taxed at 20% with indexation benefit {after subtracting the inflation rate as given by Consumer Price Index (CPI)}.

  3. Dividends from debt funds are tax-free in the hands of the investor but dividend payouts from them are subjected to a dividend distribution tax of 29.12% (including cess and surcharge). This reduces the effective return on mutual funds in the hands of investors.

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