Capital Gain Tax on the Different Type of Mutual Funds

Capital Gain Tax on the Different Type of Mutual Funds

Mutual fund tax or capital gain tax on mutual fund depends on the holding period of the scheme.

Investors can earn form mutual funds in two forms – capital gains and dividends. Among these, the capital gain tax is payable at the investors end. On the other hand, the fund houses or the Asset Management Companies pay the mutual funds dividends tax or Dividend Distribution Tax (DDT) on behalf of the investors.

In this article, we will discuss the tax implications of different types of the mutual fund.

Read also: Planning for New Financial Year 2019-20

What is Mutual Fund Tax or Capital Gain Tax on a Mutual Fund?

The idea of mutual fund tax is quite simple. The primary objective of mutual fund investment is wealth creation. So, the difference between purchase and selling price of mutual funds units is your capital gains, and that can be taxable.

Let’s take an example; Mr. Dipak Jain purchased mutual fund units of Rs. 2 lakh May 1, 2017. Now, on May 1, 2019, he sold the units at 2.8 lakh. Therefore, the capital gain of Mr. Jain is of Rs. 80,000.

Now, the taxation on the capital gain will depend on the type of mutual fund and the period of investment. According to the investment period, there are two types of capital gain tax – Short Term Capital Gains Tax (STCG) and Long Term Capital Gains Tax (LTCG).

Read also: What is NPS (National Pension System)? NPS Contribution, Schemes, Tax Benefits & Login

Mutual Fund Tax basis of Holding Period and Type of Fund

The amount of tax you pay on mutual fund capital gains depends on the holding period and the kind of the scheme. Nowadays, various types of mutual funds are available in the market. So, capital gain tax calculation basis of the holding period is different for the different mutual fund. 

Mutual Fund Tax for Short Term Holding Periods

A holding period of fewer than 12 months for equity and balanced mutual funds is defined as short-term. Whereas, if the holding period is less than 36 months for debt funds that also counted as short term investment. So, the taxation for these time lap for related schemes is short term capital gain tax.

Mutual Fund Tax for Long Term Holding Periods

In case of equity mutual funds and balanced mutual funds if the holding period is 12 months or more, then LTCG tax applies on the earning from these funds. Similarly, in the case of debt funds, when the holding period is 36 months or more, then it will calculate as a long-term investment.

Type of Funds Holding period for STCG Holding period for LTCG
Equity funds Less than 12 months 12 months and more
Balanced funds Less than 12 months 12 months and more
Debt funds Less than 36 months 36 months and more

Read also: Direct Mutual Fund – Everything You Need To Know

Mutual Fund Dividend Distribution Tax (DDT)

The dividend is the annual return provided by a company to its investors out of profits made by the company. So, the dividend is an income for the investors and subject to income tax. This tax is called the Dividend Distribution Tax (DDT). In case of mutual fund investment, DDT deducted and paid by the fund house before paying the dividend to investors. Therefore, you need not pay any tax on dividends earned on a mutual fund scheme.

DDT on Different Mutual Funds

  • For the Debt funds, the DDT rate is of 25 percent. After including the health and education cess and surcharge, the rate is approximately 29%. So, this is very close to the highest tax bracket in India at 30%.  
  • However, after budget 2018 the DDT rate for equity-oriented funds is 10%. So, this rate is nearly 11.64% including the surcharge and cess.

Additionally, the dividend schemes will be non-beneficial for LTCG below Rs. 1 Lakh as other schemes are exempt from tax.

Type of Mutual Fund DDT Rate
Equity oriented schemes 10% + 12% Surcharge + 4% Cess = 11.64%
Non-equity oriented schemes 25% + 12% Surcharge + 4% Cess = 29.12%

Read also: Capital Gain Tax – STCG & LTCG

Taxation on the Different Type of Mutual Funds

Taxation on the Different Type of Mutual Funds

1. Tax-Saving Equity Funds

Equity-Linked Saving Scheme or ELSS is the most popular, hassle-free and efficient tax-saving scheme under Section 80C.

Even you can start investing in ELSS funds with a minimum of Rs.500. Also, you have an option of investing through SIPs in ELSS funds that developed a disciplined approach towards savings.

ELSS is the well-diversified equity funds with 3 years lock-in period. Therefore, returns from an ELSS investment are treated as LTCG and it will be taxable at a concessional rate of 10% if gains are over and above Rs.1 lakh.

But you must remember that ELSS funds invest in different equities. Therefore, ELSS investment is subjected to market risk.

2. Non-tax Saving Equity Funds

In the case of non-tax saving equity funds, the long-term capital gains (LTCG) is not applied if the capital gain is up to Rs.1 lakh.  But, in excess of Rs.1 lakh, the LTCG tax is applied at the rate of 10% without the benefit of indexation. This taxation rate was introduced by the government of India in Budget 2018.

On the other hand, if the units are redeemed within 12 months then the short-term capital gain tax is applied. The SCTG tax rate is 15%.

Read also: Difference between Mutual Fund and Stock Market Investment

3. Debt Funds

Investing in a debt fund is similar to giving a loan to the issuing company. Sometimes a company or issuing authority required to raise funds and borrow from the investors. So, these companies promise a steady and regular interest to the borrower in return.

Depending upon the period of holding, Debt Funds are liable to be charged two types of mutual fund taxes. These two types are the STCG from short-term investments (less than 3 years) and the LTCG from long-term investments (more than 3 years).

Therefore, the taxation rate in the long term investment is 20% after indexation. Indexation is an important factor here. Actually, the inflation rate in the year when the debt funds were bought and the year when they are sold are not the same. So, Indexation is a method of factoring in the rise in inflation in the economy that allows inflating the purchase price of debt funds to bring down the quantum of capital gains

On the other hand for the short term capital gain is also are subject to short-term capital gains tax (SCGT) as per the corresponding income tax slab.

4. Balanced Funds

Balanced Fund ensures capital appreciation and depreciates the possible risks of mutual fund investment. The balanced or hybrid fund allows a one-stop investing in a mix of debt and equity mutual funds.

The balanced mutual funds are taxed as equity funds, as it consists of more than 65% equity funds. For less than 1 year holding period, the capital gain is short term capital gain. For balanced funds, STCG tax rate is of 15% as same as non-tax saving equity funds.

On the other hand, if the holding periods is more than 1 year, and capital gains in balanced funds over Rs.1 lakh, the tax rate is 10% (Long Term Capital Gains Tax). But, gains up to Rs.1 lakh are tax exempt.

Additionally, the dividends on balanced mutual funds face a Dividend Distribution Tax (DDT) of 10%. This tax is deducted with the AMC of fund houses at the time of distributing dividends. So, the dividend is tax-free in case of the investor.

5. Systematic Investment Plan (SIP)

In SIPs, you can regularly invest a fixed amount in a mutual fund in a periodic manner. The frequency of SIP investment can be daily, weekly, monthly, quarterly, or yearly.

So, each SIP is treated as a new investment. Therefore, the capital gains are taxed separately according to the holding period and type of investment.

Read also: SIP Investment: How does SIP work? Why should start to SIP?

Let assume that you have started a SIP of Rs.15000 a month in an equity fund for 12 months. Then, each SIP will be considered a fresh investment. At the end of the tenure, if you sell all the SIPs, then everything will not be tax-free. Only the gains earned from the first SIP would be tax-free because only that investment would have completed one year. But, the rest of the gains would be subject to STCG tax.

6. Securities Transaction Tax (STT)

The securities transaction tax or STT is a turnover tax where the investor is liable to pay specified tax on the total amount paid or received in a share transaction. Along with mutual fund, the stocks, options, futures, and exchange-traded funds also come under the STT.

In case of mutual funds, the STT imposed on transactions directly with an AMC or through a stock exchange. But, it does not cover private or off-market transactions. Most importantly, STT is applied only on the sale of equity and balanced funds. But, the STT is not applied to debt funds.

Type of Transaction STT Rate
Sale of MF units with AMC 0.0010%
Sale of MF units on stock exchange 0.0010%
Non-delivery based MF sales 0.025%

Bottom Line

After budget proposal 2018, lots of changes made in mutual fund tax and taxation in other investment instruments.

But, still the tax on long-term gains is much lower than tax on short-term gains. Therefore, as longer you hold your mutual fund investment; it will be more tax-efficient.

Hope, this article will be helpful for you. If you have any queries regarding the above post, please feel free to comment. Also, you can directly email your suggestion or queries.   

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