Taxation on mutual funds and what you should know about it?

Gains from mutual funds have an aspect of taxability to them. Here’s what you should know.

Taxation on mutual funds and what you should know about it

Assets are of two types – financial and non-financial. Financial assets are liquid and non-tangible, such as stocks, mutual funds, bonds, or bank deposits. Non-financial assets are tangible and physical, such as land, vehicles etc. Certain financial assets are likely to be traded in financial markets as well.

Indians have historically invested in physical assets such as real estate. It isn’t unsurprising to come across financial portfolios in which real estate constitutes 70% of one’s holdings. However, Indian investors have matured over time and have realised the value offered by financial assets – especially mutual funds. This is evident from the fact that the Indian mutual fund industry has experienced an average annual growth rate of 12.5% in the decade between 2008 and 2018. In comparison, the Asia-Pacific market (including India) experienced a growth rate of barely 8%.

Of late, millennials have been driving growth in the mutual fund markets, with CAMS (computer age management services) recording that out of 3.8M investors onboarded in FY 2018-19, 1.7M (about 47%) were millennials. For those looking to create wealth and achieve their financial goals, mutual funds seem to be an ideal option. However, as an investor creating a financial asset by purchasing mutual funds, you should also keep in mind the taxability aspect of buying mutual fund units.

Related: Different types of funds available under mutual funds

There are three main points relating to the taxation of mutual funds as per the Mutual Funds Taxation Rules FY 2019-20. Let’s see what they are.

  1. Residential status of the investor: The residential status of the investor – whether resident or non-resident – determines the taxability of mutual funds. So, people should first determine if they are resident or non-resident in the year under consideration. NRI mutual fund investments are taxed differently from residents only in the case of non-listed non-equity funds.
  2. Types of funds (equity or non-equity): The taxability norms of mutual funds vary based on whether they are equity instrument funds or other instrument funds. If 65% or more of the mutual funds are invested in equity, they are known as equity funds. They may be small-cap, mid-cap, or large-cap funds but the equity exposure should be either equal to or more than 65%. Non-equity funds, on the other hand, hold less than 65% investment in equity. They are also known as debt funds. These funds may be income funds, short-term funds, ultra short-term funds, gilt funds, money market funds, and so on.
  3. Time period of holding the investment: How long the investment is held (the period between its date of purchase and date of sale) determines whether any gain on sale of mutual fund units will be classified as a long-term capital gain (LTCG) or a short-term capital gain (STCG). In the case of equity mutual funds, holding the units for less than a year creates an STCG and more than a year creates an LTCG. In case of non-equity mutual funds, holding the units for less than 3 years creates an STCG and more than 3 years creates an LTCG.

Related: Debunking 7 myths about ELSS mutual funds

Taxability of STCG and LTCG as per Budget 2019-20

Equity funds

Type of gain

Tax rate

Short-term capital gain

15%

Long-term capital gain

10%

*Gain upto Rs 1 lakh on a long-term equity fund is exempted from tax. However, a gain exceeding Rs 1 lakh is taxed as LTCG on an equity fund.

Non-equity funds

Type of gain

Tax rate

Short-term capital gain

Taxed as per income tax slab of individual

Long-term capital gain (for residents)

Gains taxed at 20%

*Cost of asset is as per the indexed acquisition cost for the investor

Long-term capital gain (for non-residents on listed securities)

Same as LTCG for resident investor shown above

Long-term capital gain (for non-residents on unlisted securities)

Gains taxed at 10%

*Without indexation of cost

Equity funds

STCG on equity funds is taxed at the rate of 15%, whereas LTCG on equity funds is taxed at the rate of 10%. It is important to note that a gain of Rs 1 lakh on long-term equity fund gain is not taxed and is exempt from tax. The amount of gain exceeding Rs 1 lakh is taxed as LTCG on equity fund.

Non-equity funds

STCG on non-equity funds is taxed at the rate of whatever tax slab the individual falls in with respect to all their other sources of income as well. LTCG on non-equity funds is different for residents and non-residents.

  • Residents: Gains are taxed at 20%. It is important to note that the cost of the asset is the indexed cost of acquisition in the hands of the investor.
  • Non-residents: Gains on LISTED securities are taxed in the same way as above for resident investors. However, for UNLISTED securities, LTCG is taxed at 10% but without the benefit of indexation of cost.

Related: Should you stick to the old tax regime or move to the new one? [Premium]

Taxation of mutual fund dividends

Mutual fund dividends were to be taxed in the hands of the fund houses as dividend distribution tax (DDT), and supposed to be tax-free in the hands of the receiver. In FY 2019-20, the DDT was payable by the fund house and not the individual investor and was taxed at 30%. From budget 2020-21, however, the DDT has been abolished and dividends will once again be included as income to be taxed in the hands of the individual investor. ULIP vs Mutual Fund: Where to Invest?




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