Mutual Fund Taxation in India for FY 2018
Knowing the tax consequences of all your investments including mutual funds,whether it is capital appreciation, income or profits are an important aspect of investment planning for many reasons.
For example – As per the law of the land, each citizen has to declare all taxable income correctly in their income tax returns (ITR) and pay the required tax amount. Also, if your tax liability exceeds Rs 10,000 then you should also pay advance tax in each quarter based on the accrued estimated tax liability for the entire year. In case advance tax has not been paid at the right time, you will have to pay interest on the late payment while filing the ITR.
The other important aspect is that by knowing the tax consequence of your earnings and investments you will be able to make the most efficient investment decisions. Let us understand the tax implications on mutual fund investments in India so that you can make the right investment decisions and are also able to correctly assess the tax obligations arising out of the transactions on your mutual fund investments.
Let us first know the income tax exemption limits and key income tax slabs for Resident Indians and Hindu Undivided Families (HUF).
Investor whose income exceeds Rs 50 lakhs but is less Rs 1 Crore, he or she will have to pay a surcharge of 10% on the income exceeding Rs 50 Lakhs. Investor whose income exceeds Rs 1 Crore will have to pay a surcharge of 15% on income exceeding Rs 1 Crore. Education cess at the rate of 3% will be levied on all taxpayers.
Let us now see how the returns on mutual funds in India are taxed. Precisely, there are two different kinds of returns from mutual funds – 1) Dividends and 2) Capital gains
Dividends from mutual funds
Dividends are profits distributed by the mutual fund schemes to the investors at creation intervals. The intervals are generally regular dividends which may give yearly dividends, half-yearly dividends, quarterly dividends or monthly dividends. Few schemes have option to pay weekly or even daily dividends. However, neither the dividend amount nor the frequency is certain as it is paid out of the profit made by the scheme and the distribution of same is the discretion of the fund manager.
The tax treatment of capital gains and dividend incomes are different. Tax treatment is also different for different types of mutual funds. Let us discuss it one by one.
Capital Gains on mutual funds
Capital gain is the appreciation in the value of the units of a mutual fund realized at the time of redemption. From a taxation standpoint, there are two types of capital gains.
- Short term capital gains: If the units are sold within the period defined under tax laws, then it leads to short term capital gain.
- Long term capital gain: If the units are sold after a period defined under tax laws, then it leads to long term capital gain.
The tax treatment of short term and long term capital gains and dividend incomes are different. Tax treatment is also different for different types of mutual funds which are classified (for the purpose of taxation) as equity funds and non-equity funds.
You may also like to read what is the tax on mutual fund income in India
Let us see how equity or equity oriented mutual funds and non-equity mutual funds are taxed.
Equity or equity oriented mutual funds
From taxation perspective, a fund in which at least 65% of the portfolio is allocated to equities (stocks) is an equity mutual fund. Some of the well-known categories such as Diversified equity funds, Large cap Fund, Mid and small cap funds, thematic or sector funds, Equity Linked Savings Schemes (ELSS),Balanced funds,index funds, Equity Savings Fund and arbitrage funds are categorized as equity funds from a tax perspective.
The minimum holding period for availing long term capital gains tax benefit in equity mutual funds is one year. Short term capital gains (if the units are sold before one year) in equity mutual funds are taxed at the rate of 15% plus 3% cess.
There is no capital gains tax on the redemption of equity mutual fund units if held for a period of more than one year.
Dividends paid by equity or equity oriented mutual funds are tax free in the hands of the investors and even the dividend distribution tax (DDT) is zero for the fund house.
Non-Equity mutual funds
Non-Equity mutual funds from a tax standpoint includes all category of debt mutual funds like liquid funds, ultra short term debt funds,fixed maturity plans (FMPs), short term debt funds, dynamic bond funds,income funds, gilt funds and also the hybrid debt oriented funds (popularly knows as MIP).
Even the fund categories like, Gold funds, fund of funds, asset allocation funds and international funds are also treated as non- equity mutual funds.
The minimum holding period for short term capital gains in non-equity mutual funds is three years. Short term capital gains (if the units are sold before three years) in non-equity mutual funds are taxed as per applicable tax rate of the investor.
Therefore, assuming your taxable income is above Rs 10 lakhs then short term capital gains tax of your non-equity mutual debt fund redemption is 30% + applicable cess and surcharges.
Long term capital gains of non-equity mutual funds are taxed at 20% with indexation. To calculate capital gains with indexation, you should index your purchasing cost by multiplying the purchasing cost with the ratio of the cost of inflation index of the year of sale and cost of inflation index of the year of purchase, and then subtract the indexed purchasing cost from sales value.
Like equity mutual funds dividends distributed by the non-equity mutual funds are also tax free in the hands of the investor, but the AMC has to pay dividend distribution tax (DDT) on the dividends paid by the non-equity mutual funds. In this case, the Dividend Distribution Tax (DDT) is 25% + 12% surcharge + 3% cess = 28.84% for Resident Indians and HUFs.
Summary of Equity and Non-Equity Mutual Fund Taxation
The table below summarizes the taxation of equity and non-equity mutual funds in India.
Saves taxes by Investing in Equity Linked Savings Schemes (ELSS)
Investments in Equity Linked Savings Schemes (ELSS) qualify for deduction from your taxable income under Section 80C of the Income Tax Act 1961. The maximum investment amount eligible for tax deduction under Section 80C is Rs 1.50 Lakhs. As you may know Under Section 80C of The Income Ta Act 1961, other than mutual funds ELSS schemes, premium paid on insurance policies, investment in PPF, NSC and tax savings fixed deposits etc. are also eligible investments and the limit of Rs 150,000 in a year is the combined total of all these investments.
Therefore, those investors who are in the highest tax bracket (30%) can save up to Rs 46,350 in taxes (Rs 1.5 Lakhs X 30.9% tax + cess) by investing in mutual fund ELSS schemes.
See what the return of top ELSS funds is in the last 5 years
In this article, we have discussed the implications of taxes on your mutual fund investments. When filing Income Tax Returns (ITR) for FY 2018 (Assessment year 2019), you should carefully go through all the mutual fund transactions made in FY 2017 – 2018 and see if profits made in FY 2017 – 2018 has any tax consequences. You should prepare a profit and loss statement (capital gain and loss) by obtaining statements from the respective AMCs or from your mutual fund advisor, analyze it carefully before filing the returns.
If you have not yet made the tax saving investments for the current financial year, then you should act fast and invest in ELSS mutual funds.
Mutual fund taxation discussed in this post is applicable for mutual funds transactions in FY 2017-2018 (Assessment year 2018-19). As discussed, you should arm yourself with knowledge about mutual fund taxation so that you meet your investment objectives by maximizing the post-tax returns from your mutual fund investments.
Mr. Ajay Kumar Jain, M.Sc, Chief Managing Director
Being the Chairman cum Chief Managing Director, he focuses on holistic investment planning and wealth management and tries to make investment planning simpler for retail and HNI investors. Investor education is one of the prime things that Mr. Ajay Jain focuses on as he believes financial education is the foundation of successful investing. With over two decades of experience, Mr. Jain has made a mark in the Indian mutual fund industry due to his compassion and sheer hard work.