Impact of Taxation on Mutual Funds
12 January, 2024
Mutual Funds 101: Impact of Mutual Fund Taxation and Tips to Minimise Your Liability
Over the years, mutual funds have gained the reputation of being profitable investments that help you reach your financial objectives. Additionally, mutual funds are known for their tax efficiency and their ability to generate yield returns accordingly. Hence, while investing, it is crucial to consider the implications of taxation on mutual funds. Continue reading to learn more about the effect of tax on mutual funds and how you can mitigate your tax liability.
What is the Impact of Tax on Mutual Fund Investments?
Much like the returns from any other investment vehicle, returns on mutual funds are subject to taxation. The following variables will help you understand how mutual funds are taxed.
Type of Fund: How your mutual fund investment will be taxed depends on whether you’ve invested in equity-based or debt-oriented schemes.
Capital Gains: The tax you pay on your mutual funds also depends on the capital gains, which is the profit earned by selling an asset at a higher rate than the buying price.
Dividends: Dividends are portions of the accumulated profits distributed to investors by the mutual fund house.
Holding Period: The holding period refers to the duration between the buying and selling of mutual fund units. Usually, you have to pay less tax if the holding period is longer, which encourages investors to retain their investments for extended periods.
Investors earn profits on mutual funds via capital gains and dividends. However, capital gains are only taxed upon the redemption of your mutual fund units. Hence, this type of tax has to be paid when you submit your income tax returns for the upcoming fiscal year. On the other hand, dividends are subject to immediate taxation.
Taxation on Dividends Earned on Mutual Funds:
Since the Finance Act of 2020 eliminated DDT (Dividend Distribution Tax), investors are now required to pay tax on the entire dividend income under the income tax bracket. Additionally, dividends are also subject to TDS (Tax Deducted at Source). The Asset Management Company (AMC) deducts 10% TDS from your dividends if it exceeds ₹5,000. You can claim the TDS amount while paying your taxes and only claim the remaining amount.
Taxation on Capital Gains on Mutual Funds:
The tax treatment of capital gains earned from mutual funds depends largely on the type of scheme and the holding period.
Equity Funds: An Equity Fund is a mutual funds scheme that pools investments into shares of companies. Typically, these funds have an equity exposure of 65%. If you have invested in equity funds, any short-term capital gains earned on the same will be taxed at a rate of around 15% if you sell units within a holding period of a year. Alternatively, if you sell such units after a year, then you earn long-term gains. Such gains are tax-free up to ₹1 lakh p.a. Exceeding this threshold, long-term capital gains are subjected to a tax of 10% without any benefit of indexation. In both instances of short-term and long-term capital gains, a 4% cess and a surcharge apply.
Debt Funds: As of 1 April 2023, debt funds are not eligible for indexation benefits and will be treated as short-term capital gains. The returns from debt funds will be combined with your taxable income and subject to taxation at your applicable income tax slab rate.
Now that you have a better understanding of how income tax on mutual funds works, you can invest accordingly and file your returns in compliance with tax laws. To invest in tax-efficient mutual funds, head straight to HDFC Bank and open an Investment Services Account today!
* Terms and Conditions apply. The information provided in this article is generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. You are recommended to obtain specific professional advice from before you take any/refrain from any action.
