How are returns on mutual funds taxed in India? Long-term and short-term capital gainsitle]

Equity and debt mutual funds are taxed differently based on the holding period. In this article, we will explore all aspects of mutual fund taxation.

How are mutual funds taxed

Historically, investments in equity mutual funds over the long term have given inflation-beating high returns. When you earn good returns from your mutual fund investments, you have to pay taxes. Income tax on mutual funds mainly depends on two factors: the type of mutual fund (equity or debt) and the duration of holding. In this article, we shall discuss the fundamentals of taxation of mutual funds.

Capital gains

Before we get into the details of tax on mutual funds, we need to understand the concept of capital gain. The profit earned from mutual funds is considered as capital gains. From a taxation point of view, depending on the duration of mutual fund holding, capital gains can be classified as short-term capital gains (STCG) or long-term capital gains (LTCG). We will discuss these terms in detail later.

Taxation of equity mutual funds

For taxation purposes, a mutual fund scheme that invests a minimum of 65% of its total assets in equity and equity-related instruments is classified as an equity mutual fund scheme.

  • Short-term capital gains (STCG) tax: When an equity mutual fund scheme is held for less than 12 months, the capital gains are classified as short-term capital gains (STCG). The STCG tax on equity mutual fund capital gains is levied at 15%.
     
  • Long-term capital gains (LTCG) tax: When an equity mutual fund scheme is held for more than 12 months, the capital gains are classified as long-term capital gains (LTCG). LTCG tax on mutual fund gains is levied at 10%, without indexation, on incremental gains above Rs 1,00,000 in a financial year. 

For example, in the last financial year, let us assume that Kartik booked long-term capital gains of Rs 1.5 lakh on his equity mutual funds. In this case, the first Rs 1 lakh will be exempt (tax-free). The remaining gains from the sale (Rs 50,000) will be taxed at 10%. So, Kartik will have to pay LTCG of Rs 5000.

Related:  What Are The Income Tax Implications Of Selling Or Switching Mutual Funds?

Taxation of equity mutual funds

Taxation of equity mutual funds

 

Taxation of debt mutual funds

For taxation purposes, any mutual fund scheme that is not an equity scheme is classified as a debt mutual fund scheme. So, for taxation purposes, debt mutual funds will also include hybrid schemes, dynamic asset allocation schemes, multi-asset allocation schemes, arbitrage schemes, equity savings schemes, index schemes, etc., where the equity allocation is less than 65%.

  • Short-term capital gains (STCG) tax: When a debt mutual fund scheme is held for less than 36 months, the capital gains are classified as short-term capital gains (STCG). STCG is added to the individual’s income and then taxed as per the individual’s overall income and tax slab.
     
  • Long-term capital gains (LTCG) tax: When a debt mutual fund scheme is held for more than 36 months, the capital gains are classified as long-term capital gains (LTCG). LTCG tax on debt mutual fund capital gains is levied at either 20% (with indexation benefit) or 10% (without indexation benefit).

Taxation of debt mutual funds

Taxation of debt mutual funds

Related: What Are The Income Tax Implications Of Selling Or Switching Mutual Funds?


Taxation of SIPs

In the case of Systematic Investment Plans (SIPs), every instalment will be counted as a new investment. Accordingly, the holding period of less/more than 12 months for determining the application of STCG/LTCG will apply to every SIP instalment in an equity mutual fund. Similarly, the holding period of less/more than 36 months for determining the application of STCG/LTCG will apply to every SIP instalment in a debt mutual fund.

Tax harvesting

Every year, LTCG tax is exempt on the first Rs 1 lakh capital gains on equity mutual funds. You can use this provision to your benefit by booking some profits (LTCG of up to Rs 1 lakh) every year. It will help you save Rs 10,000 (10% of Rs 1 lakh) in LTCG tax.

 

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