Taxation on Mutual Funds 2022 – Tax Benefits of Investing in Mutual Funds
When investing in mutual funds, you need to be aware of the taxation aspects of mutual funds. You need to know which mutual funds provide you tax benefits at the time of investment and how your returns are taxed at the time of redemption. This article discusses the taxation of mutual funds in 2022 – Tax benefits of investing in mutual funds.
Tax on mutual funds
To understand the taxation of mutual funds, you need to first classify them as equity funds and non-equity (or debt funds) as the taxation of these mutual fund categories is different.
Equity mutual funds: Any mutual fund scheme where a minimum of 65% of its total assets are invested in equity and equity-related instruments, at all times, is known as an equity mutual fund.
- Non-equity mutual funds: From a taxation point of view, any mutual fund scheme that is not an equity scheme is classified as a non-equity mutual fund scheme and taxed accordingly.
How does an investor earn returns from mutual funds?
An investor makes returns from mutual funds in two ways:
Dividend: When a mutual fund scheme books profits on the securities that it holds and distributes the profits to its unitholders, it is known as a dividend. Every unitholder gets dividends in proportion to their units in the mutual fund scheme.
- Capital gain on the mutual fund: When a mutual fund unitholder sells their units at a price higher than at which they bought them, the difference is known as capital gains.
We will discuss the tax on mutual fund returns.
Tax benefit on mutual funds at the time of investment
If an investor invests in an equity-linked savings scheme (ELSS), they can avail of a deduction from their taxable income under Section 80C of the Income Tax Act. The maximum deduction allowed in a financial year is the actual amount invested or Rs. 1,50,000, whichever is lower. Usually, other mutual fund schemes, apart from ELSS, don’t provide income tax benefits on mutual funds at the time of investment.
Mutual fund dividend tax
Any dividend that an investor receives from a mutual fund is added to their overall income. The dividend is then taxed as per the income slab that an individual falls in. If the overall dividend received by an individual exceeds Rs. 5,000 in a financial year, a TDS of 10% will be deducted. To avoid the TDS, an individual can submit Form 15H (for senior citizens) or Form 15G (for other individuals).
Taxation of capital gains
The taxation of capital gains depends on whether a mutual fund is an equity or non-equity fund.
Tax on equity mutual funds
- Short-term capital gains (STCG) tax: If you sell your equity mutual fund units within twelve months of purchase, the capital gain will be classified as short-term capital gain (STCG). The short-term capital gain (STCG) tax will be levied at 15%.
Long-term capital gains (LTCG) tax: If you sell your equity mutual fund units after twelve months of purchase, the capital gain will be classified as long-term capital gain (LTCG). Every financial year, the first Rs. 1 lakh long-term capital gain will be exempt from taxation. The incremental long-term capital gain above Rs. 1 lakh will be taxed at 10%.
Tax on debt mutual funds
- Short-term capital gains (STCG) tax: If you sell your debt mutual fund units within thirty-six months of purchase, the capital gain will be classified as short-term capital gain (STCG). The short-term capital gain (STCG) will be added to your overall income and taxed as per the income tax slab that you fall in.
Long-term capital gains (LTCG) tax: If you sell your debt mutual fund units after thirty-six months of purchase, the capital gain will be classified as long-term capital gain (LTCG). The long-term capital gain (LTCG) tax will be levied at 20% with indexation benefit and 10% without indexation.
Tax on hybrid mutual funds
The taxation of a hybrid mutual fund scheme will depend on its equity holding. If the equity holding at all times is at a minimum of 65% or higher, it will be classified as an equity fund, and an investor's returns will be taxed like that of an equity fund.
If the equity holding of a hybrid fund falls below 65% at any time, it will be classified as a non-equity fund, and an investor's returns will be taxed like that of a non-equity fund.
Taxation of capital gains when investing through SIPs
Many investors invest in mutual fund schemes through the systematic investment plan (SIP) route. In this case, the holding period of 12 months (for equity funds) or 36 months (for debt funds) will apply for each SIP instalment to determine the applicability of STCG or LTCG.
For example, Abhijit starts a monthly SIP of Rs. 1,000 in an equity mutual fund scheme. In the 13th month, he redeemed all the units. In this case, only the first SIP instalment completed 12 months, and hence LTCG will apply to it. All the remaining 11 SIP instalments did not complete 12 months, and hence STCG will apply to them.
While investing in mutual funds, an investor needs to be clear about taxation. Their actual returns will depend on the post-tax returns rather than the scheme returns. If you plan your mutual fund investments keeping in mind the taxation aspects at the time of investment and redemption, you can plan for your financial goals in a tax-efficient manner.
To start investing in mutual fund schemes as per your appropriate asset allocation, download the Glide Invest App from Google Play Store or Apple App Store and get started.