Tax on Mutual Funds: Taxation of Debt and Equity Mutual Funds
The income you earn through investment in mutual funds is taxable. So, it is important to know how tax on mutual funds is applied. Also, taxation of debt and equity mutual funds is treated differently.
Mutual funds offer investors returns in two forms – dividends and capital gains.
Dividends are paid out of the profits of the company if any.
Capital gains are realized due to the appreciation in the price of the mutual fund units. Both dividends and capital gains are taxable in the hands of investors of mutual funds.
As per the amendments made in the Union Budget 2020, dividends received by investors are added to their taxable income and taxed at their respective income tax slab rates. But, a TDS of 10% is deducted by the company if the amount of dividend exceeds Rs5000.
Previously, before April 2020, dividends were tax-free in the hands of investors as the companies paid dividend distribution tax (DDT) before sharing their profits with investors in the form of dividends.
The short-term and long-term capital gains offered by mutual funds are taxed at different rates.
Taxation of Capital Gains on Equity Funds
Equity funds are those mutual funds whose portfolio’s equity exposure exceeds 65%. As mentioned above, you realise short-term capital gains on redeeming your equity fund units within a holding period of one year. These gains are taxed at a flat rate of 15%, irrespective of your income tax bracket.
You make long-term capital gains on selling your equity fund units after a holding period of one year or more. These capital gains of up to Rs 1 lakh a year are tax-exempt. Any long-term capital gains exceeding this limit attracts LTCG tax at the rate of 10%, and there is no benefit of indexation provided.
Taxation of Capital Gains on Debt Funds
Debt funds are those mutual funds whose portfolio’s debt exposure is in excess of 65%. As mentioned in the table above, you get short-term capital gains on redeeming your debt fund units within a holding period of three years. These gains are added to your taxable income and taxed at your income tax slab rate.
Long-term capital gains are realised when you sell units of a debt fund after a holding period of three years. These gains are taxed at a flat rate of 20% after indexation. Also, you are levied with applicable cess and surcharge on tax.
Securities Transaction Tax (STT)
Apart from the tax on dividends and capital gains, there is another tax called the Securities Transaction Tax (STT). An STT of 0.001% is levied by the government (Ministry of Finance) when you decide to buy or sell mutual fund units of an equity fund or a hybrid equity-oriented fund. There is no STT on the sale of debt fund units.
Now, we know it’s not always about gains. There can be losses as well. The losses if any can be set off with the profits. But, there are certain rules as regards to setting off. ST loss can be set off against ST gains only. Likewise, LT loss can be set off against LT gains only.
If in case, the losses are greater than the profits, the losses can be carried forward to the next year, where they can be set off against the profits of next year.
So, when you invest in mutual funds, you should also know how mutual fund income is being taxed.
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