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Understanding How Mutual Funds Are Taxed

A mutual fund is an economical financial product that helps accomplish this purpose by increasing the value from time to time. The ultimate goal of mutual funds is profit generation. Gains from mutual funds are taxable, like every other asset. The tax you pay on the mutual fund investments greatly depends on aspects like the kind of funds you invest in, the investment length, and the income tax bracket.

Mutual fund investors generally benefit from the investments through dividends and capital appreciation. A systematic investment plan (SIP) can be the best instrument to save tax with a good amount of returns on your investments. Below are some of the rules of different taxes:

  • Tax on Equity Fund

Tax on Equity Funds depends on whether the profit on the sale is categorized as short-term or long-term capital gains; the equity mutual fund is subject to a tax of capital gains. Both non-resident and residents pay similar capital gains tax rates.

Short-term capital gains abbreviated as STCG are taxed at 15% upon the redemption of equity fund units. Long-term capital gains or LTCG on equities funds up to Rs 1 lakh are not taxable. But, LTCG on stock fund redemptions that are more than Rs 1 lakh is taxed at 10%, without any indexation benefit.

  • Tax on Debt Funds

If you trade in a debt fund within three years, you produce short-term capital gains. These gains are then added to your overall income and taxed in line with your tax bracket. When the debt fund assets are redeemed after three years, you’ll realize long-term capital gains. These gains remain taxed at the rate of 20% after indexation.

In debt funds, long-term is expressed as the holding period of 3 years or longer, and 20% LTCG tax is levied on the assets with indexation, which indicates that the purchase cost is adjusted upwards for inflation while computing capital gains. Gains from investments get to be less than three years are subject to the short-term capital gain tax, which is the maximum income tax bracket for everyone.

  • Tax on Hybrid or Balanced Funds 

When a hybrid fund’s equity exposure surpasses 65 percent, then the fund is taxed like an equity fund. If it is less than, the debt fund provisions of taxation applied. Consequently, one must be well-informed about the equity exposure before investing in a hybrid fund to appropriately manage your taxes.

  • Mutual Fund Dividend 

In the case of mutual fund dividends, investors have no tax liability. Whereas Dividends reach investors after subtraction of 11.648%, Dividend Distribution Tax (DDT) including cess and surcharge, reducing the overall in-hand return. The debt mutual fund distribution is free from tax and in the hands of the investor. At the same time, dividend disbursement is subject to 29.12 % dividend distribution tax, including surcharge and cessation, which will effectively lower the in-hand returns of investors.