Capital Gain Taxation

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How are Mutual Funds Taxed

Mutual Funds are probably the most tax efficient investment options out there for both equity and debt.

Are gains from investment in mutual funds taxable?

Yes they are.

The biggest component of Mutual Fund taxation is the Capital Gains Tax (the tax on profits) which is discussed below. There are some other taxes as well like STT and Dividend tax which are covered in a more detailed.

Important points about Mutual Fund taxation
  • Capital Gains Taxes are applicable only when you sell and only on the gains made on the units being sold.
  • For Resident Indians, the tax applicable is NOT deducted by the Mutual Fund. Tax is to be paid by you before the financial year ends on your own.
  • In case of NRIs investment in mutual funds, the Mutual Funds will deduct the tax (TDS) when you redeem the investments.
  • Capital Gains Taxes depend not only on amount of gains but also on the type of investment (equity or debt) and the length of time the investment is held for (short term or long term). See the summary table below.
Type of Mutual Fund Duration of Investment STCG/LTCG Tax Applicable on Gains* TDS*
Equity Mutual Funds Less than equal to 1 year STCG 15% No TDS for Resident Indians, @ 15% of gains for NRIs
Greater than 1 year LTCG 10% of gains above Rs. 1Lakh^ No TDS for Resident Indians, @ 10% of gains for NRIs
Debt Mutual Funds Less than equal to 3 year STCG @ your Income Tax Level No TDS for Resident Indians, @ 30% of gains for NRIs
Greater than 3 year LTCG Resident Indians: 20% after indexation** NRIs: 10% without indexation No TDS for Resident Indians, @ 10% of gains for NRIs
^ LTCG in Stocks and Equity Mutual Funds upto Rs. 1 lakh in a financial year will be free of tax. Tax at 10% applies to total LTCG exceeding Rs. 1 lakh at a PAN level for a financial year. LTCG tax rate was 0% earlier.
* Surcharge and cess extra for all taxes and TDS rates
** Indexation means that the cost of purchase can be increased by inflation while calculating taxable gains.
  • If more than 65% of the corpus of mutual funds scheme is invested in domestic equity and equity oriented securities, then it is treated as an equity fund for taxation purposes, otherwise it is considered as a debt fund. Gold Mutual Funds and Mutual Funds primarily investing in foreign equities are also taxed as debt funds.
  • LTCG in stocks and equity Mutual Funds upto Rs. 1 lakh in a financial year will be free of tax. LTCG Tax at 10% will only apply to equity LTCG beyond Rs. 1 lakh at a PAN level for a financial year.
  • Moreover, if the investments in equity mutual funds was made before 31 Jan 2019, then the capital gains 31st Jan 2019 will be exempted from being taxed and considered as ‘Grandfathered’.
  • In case of SIPs, each SIP instalment is treated as a fresh investment with its own holding period and the gains will be taxed accordingly. So if you had been investing via a monthly SIP for 2 years in an equity fund and are now redeeming your investments, your first SIP instalment has been invested for 2 years and will qualify as a long-term investment whereas your 13th instalment has only been invested for 11 months and hence will be considered as a short-term investment and the any gains on that instalment will be taxed accordingly at 15%.
  • Indexation means after subtracting inflation from your overall returns i.e. if overall returns are 8% and inflation is 7% then tax applicable is 20% of (8%-7%) = 20% of 1% = 0.2%.
  • Debt Mutual Funds are 10 times more tax efficient than Fixed Deposits while providing similar safety and returns because of indexation benefits. In FD all gains are taxed at your current income tax level irrespective of how long the FD was kept for. So in this example if you are in the 30% bracket, your tax applicable would be 30% of 8% i.e. 2.4% – more than 10 times than that of debt funds!
  • Dividends are tax-free in the hands of the investor but that’s because TDS gets deducted on them by the Mutual Fund company while paying them out. In case of equity funds the dividend tax is 11.648% (10% + cess + surcharge) and in case of debt funds it is 29.12% (25% + cess + surcharge).
  • [Advanced stuff] Capital Losses: In case of losses in one investment, a tax deduction can be claimed for profits in another investment. These deductions can also be carried forward to be offset against future gains, if and when they happen. (This is an oversimplified version of taxation of losses – you can ignore it for now, you will know when you need it).

Whenever you consider selling your investments, take into account the potential tax implications or they could eat into your returns. More reasons to stay invested for the long-term.