Tax on Mutual Funds in India – STCG, LTCG, Dividend & ELSS Guide

Types of Taxes on Mutual Funds

The taxation of mutual funds mainly includes capital gains tax, Securities Transaction Tax (STT), and tax on dividend income received under the IDCW option.

What is Capital Gains Tax?

Capital gain tax refers to the tax payable on capital gains realised from selling or redeeming of mutual fund units above the initial cost of acquisition. The tax to be paid varies with the type of mutual fund and the period of investment.

Example:

Suppose you invest ₹2,00,000 in an equity mutual fund. After a few years, you redeem the investment for ₹2,60,000.

• Purchase value = ₹2,00,000
• Redemption value = ₹2,60,000
• Capital gain = ₹60,000

The tax payable on mutual fund capital gains vary depending on whether the capital gains fall into the category of Short-Term Capital Gains (STCG) or Long-Term Capital Gains (LTCG).
 

Short-Term Capital Gains (STCG) Tax on Equity Mutual Funds

When the equity mutual fund units are sold prior to meeting the stipulated period for categorizing the gains as long term, the capital gains are considered Short-Term Capital Gains (STCG). 

As per the current taxation norms, the Short-Term Capital Gains (STCG) from equity mutual funds is taxed at 20%.

Example:

Suppose an investor purchases equity mutual fund units for ₹1,50,000 and redeems them after eight months for ₹1,90,000.

• Purchase value = ₹1,50,000
• Redemption value = ₹1,90,000
• Short-term capital gain = ₹40,000

Since the units were redeemed within the short-term holding period, the applicable STCG on mutual funds is calculated on the gain of ₹40,000 at the prevailing tax rate.
 

Long-Term Capital Gains (LTCG) Tax on Equity Mutual Funds

Long-Term Capital Gain is applicable where the redemption takes place after meeting the stipulated holding period required for long-term investment in the equity mutual funds. 

Under the latest tax norms, tax on long term capital gain arising from mutual funds is taxed at the rate of 12.5% of gain in excess of ₹1.25 lakh per annum.

Example:

An investor purchases equity mutual fund units for ₹5,00,000 and redeems them after three years for ₹7,20,000.

• Purchase value = ₹5,00,000
• Redemption value = ₹7,20,000
• Long-term capital gain = ₹2,20,000

After considering the applicable exemption limit, tax is calculated on the taxable portion of the long-term capital gain according to the prevailing LTCG provisions.
 

Taxation on Debt Mutual Funds

The tax treatment of debt mutual funds depends on the type of scheme and the applicable tax provisions.

For specified debt mutual funds purchased on or after the applicable date under current tax rules, capital gains are generally taxed according to the investor's applicable income tax slab, irrespective of the holding period.

Debt-oriented mutual funds that do not fall under the specified category are taxed according to the prevailing capital gains provisions applicable to their classification. Investors should review the tax treatment of the scheme before investing, as taxation may vary depending on the nature of the fund.
 

Taxation on Hybrid Mutual Funds

Hybrid mutual funds invest in a combination of equity and debt securities. Their tax treatment depends on the proportion of equity exposure in the scheme as defined under the applicable tax rules.

*The applicable tax treatment depends on the prevailing Income Tax provisions and the classification of the mutual fund scheme.

SIP Taxation – How Each Instalment is Taxed

A Systematic Investment Plan (SIP) involves investing a fixed sum on a consistent basis. The taxation rules consider each SIP installment as an individual investment. Thus, the holding period for each installment gets computed separately. 

At the time of redemption, the FIFO principle is applied. It is based on the principle of redemption of the units acquired first.

Example:

Suppose an investor starts a monthly SIP of ₹5,000.

• January: 250 units purchased
• February: 230 units purchased
• March: 240 units purchased

If the investor redeems 300 units, the redemption is calculated as follows:

• First 250 units are considered from the January instalment.
• The remaining 50 units are considered from the February instalment.

The holding period and applicable tax are determined separately for each instalment based on its purchase date.
 

Dividend Tax on Mutual Funds (IDCW)

Some mutual fund schemes offer the Income Distribution cum Capital Withdrawal (IDCW) option, under which investors may receive periodic payouts from the scheme.

Dividend income received under the IDCW option is taxable in the hands of the investor according to the applicable income tax slab. The Asset Management Company (AMC) may also deduct Tax Deducted at Source (TDS) where applicable under the prevailing income tax provisions.

Investors should note that IDCW distributions reduce the scheme's NAV by the amount distributed and may have tax implications depending on their overall taxable income.
 

Securities Transaction Tax (STT)

Securities Transaction Tax (STT) is levied on specified equity-oriented mutual fund transactions carried out through recognised stock exchanges or during redemption, wherever applicable.

*STT rates are subject to changes under applicable tax laws.

Unlike capital gains tax, STT is collected at the time of the transaction and is separate from the tax payable on capital gains.
 

Equity Linked Savings Schemes (ELSS) are equity-oriented mutual funds that qualify for tax deductions under Section 80C of the Income-tax Act, subject to the applicable conditions.

ELSS investments come with a mandatory lock-in period of three years, making them one of the tax-saving investment options available under Section 80C.

ELSS under the Old vs New Tax Regime

Before investing for the ELSS tax benefit, investors should evaluate which tax regime applies to them and whether they are eligible to claim deductions under Section 80C.

Tax-Saving Strategies for Mutual Fund Investors

Investors can manage their mutual fund tax liability by understanding the applicable tax rules and planning their investments carefully.

• Invest For the Long Term: Holding eligible equity mutual funds for the long term may result in different tax treatment compared to short-term redemptions.
• Consider ELSS For Tax Savings: Investors following the old tax regime may consider ELSS investments to claim deductions under Section 80C, subject to the prescribed limit.
• Plan Redemptions Carefully: Redeeming investments over different financial years may help investors use the available LTCG exemption, wherever applicable.
• Understand SIP Taxation: Since every SIP instalment has its own holding period, reviewing the purchase dates before redemption can help estimate the applicable capital gains tax.
• Maintain Investment Records: Keeping records of purchase dates, redemption values, and capital gains can make tax calculation and return filing easier.
   

Conclusion

The tax on mutual funds is determined by various criteria like the kind of mutual fund scheme, the duration of holding the mutual funds, and the kind of returns made from it. It is important that one gets to know how the STCG for mutual funds, LTCG for mutual funds, dividend, and ELSS are taxed. The knowledge of the tax implication of various mutual funds helps one determine the taxes to be paid and invest in an effective manner.