How is Income from Mutual Funds taxed?

Priyanka Sharma

20 Jun 2017

New Page 1

India is a fairly non-tax compliant economy. This is a reality! Most of the investment schemes that the government unfolds for its citizens are utilized by many as a part of their tax saving initiative, rather than their saving initiative. While the income of the salaried class is tabbed correctly as well as their interest income through the slab rate, the gains received from mutual funds, also called capital gains is taxed under separate provisions.

Mutual fund investors remain perpetually complexed about the taxation from returns of investments. Investments in mutual fund are subject to scrutiny as it involves a huge amount as well as an appetite for risk. Financial managers are always quizzed about the possibility of tax evasion, deduction and payment. The reason for the numerous questions and no uniformity in the answers of the financial experts is due to difference in treatment of mutual fund returns and different ways of calculating its tax liability.

The profit or returns earned from mutual funds are taxed under the category of 'Income from Capital Gains.' Capital gains can be short-term or long-term and this division is based on the holding period of investments. Tax rates are definitely different for both with the rules of capital gains differing for equity as well as non-equity schemes.

There is too much information to be processed, so get ready for it.


Taxation: Equity Schemes

Mutual fund schemes that invest 65% of their total corpus into equity instruments are subjected to taxation under the equity scheme provision. If an equity mutual fund is held for more than a year than the returns from that equity mutual fund are taxed under long term capital gains. The current income tax laws have exempted such returns completely from the burden of paying income tax.

Returns held for less than a year or a year are treated under the short-term gain and the returns from the same are taxed at a rate of 15%.

Taxation: Debt Schemes

Mutual fund schemes that do not invest more than 65% of the corpus in equity are termed non-equity funds and they are taxed separately. Debt mutual funds are within the ambit of this category. Gold funds, fund of funds, international funds too are categorized as non-equity schemes when it comes to taxation.

The returns of non-equity funds that have been held by the investor for more than three years are treated under long-term capital gains and the returns are taxed at 20 per cent with the indexation benefit.

What is Indexation?

It is a process by which the purchase cost is inflated to account with the help of a price index. By indexation an investor achieves a relief from taxable profits.

Investments that are held for less than three years or three years than the returns on the mutual fund scheme is considered under short-term capital gains. Such gains are added to the income and they are taxed as per the income tax rate applicable.

Taxation: Hybrid Schemes

Hybrid schemes can be either equity-oriented or debt-oriented. Before the initial investment in the equity, the information document would provide details on the specific investment pattern, making it clear for the investor that the mutual fund scheme is an equity fund or a debt fund.

Investors are expected to pay close attention to details in the terms and conditions while opting for investment in hybrid scheme because the tax liability differs from the above two described earlier.

Calculating the Holding Period

The date of purchase or investment in the mutual fund till the day it is sold is classified as the holding period. In case of a Systematic Investment Plan (SIP), an investor purchases certain units or shares of the scheme every month or quarter and the holding period for all of these need to be calculated individually.

Calculating the Taxed Dividends

Investors often invest in a mutual fund scheme under the dividend option. Investors under this option receive annual dividends and are not liable to pay any tax on them as they are exempted from income tax in both equity as well as the debt investment scheme. Though an individual investor is not taxed on dividends, mutual fund houses before declaring the dividends pay a distribution tax of 28.84%.

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Why to Choose Mutual Funds Instead of Directly Investing Into Equities?

Whether to invest in equities or mutual funds is a question that has plagued every investor. As someone who needs the best value for his/her investment should you invest in equity directly or via mutual funds?

Let’s start by first understanding what these two terms ‘equities’ and ‘mutual funds’ stand for-

Equities- Equities generally represent ownership of a company. If you own any equity in a company, you are a part owner of the said company (depending on how much equity you own).

Mutual Funds – It is an investment scheme which is professionally managed by an asset management company. It pools together the resources of a group of people and invests their money in equities, debentures, bonds and other securities.

Why choose mutual funds over equities?

For people who’ve never invested in either stocks or mutual funds, it is hard to know which is better and where to start. Broadly speaking, if you are a novice investor, mutual funds are not only less risky but also way easier to manage. Here are some ways in which investing in mutual funds is beneficial as opposed to investing in equities -

Diversification

Mutual funds provide more diversification as compared to an individual equity stock. When you invest in equity, you are investing in a single company which has its inherent risk. For example, if you invest Rs.20,000 in buying equities of one company, you could face a total loss if that particular company performs poorly in the market.  

If you invest the same amount in mutual funds, it will be invested in different kinds of stocks and financial instruments, high-risk and low-risk both, so you might not face total loss even if one company does poorly.

Scale of Investment and Lower Costs

For an individual investor buying and selling stocks is a difficult task due to its high price. Thus, any gains made from stock appreciation are nullified if the overall trading costs are considered. Comparatively with mutual funds, as the money is pooled from a large number of investors, the cost per individual is lowered.  

Another advantage of mutual funds is that you don’t need to invest large sums of money. Buying equities for a profitable venture needs huge amounts of money, a minimum of few lakhs. With mutual funds, you can start with Rs.1000 and earn profits on that as well.

Convenience

Keeping an eye on the markets everyday is a time-consuming business, especially if you are investing as a side gig. There are people who spend their lives studying the market and still end up sustaining heavy losses. Though investing in mutual funds does not guarantee high returns, it is stress-free and needs less work as compared to investing in equities.

To sum it up

It is important to remember that mutual funds have their own disadvantages as well. Thus, as with any financial decision, educating yourself and understanding the suitability of all the available options is the ideal way to invest. 


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How is Income from Mutual Funds taxed?

Priyanka Sharma

20 Jun 2017

New Page 1

India is a fairly non-tax compliant economy. This is a reality! Most of the investment schemes that the government unfolds for its citizens are utilized by many as a part of their tax saving initiative, rather than their saving initiative. While the income of the salaried class is tabbed correctly as well as their interest income through the slab rate, the gains received from mutual funds, also called capital gains is taxed under separate provisions.

Mutual fund investors remain perpetually complexed about the taxation from returns of investments. Investments in mutual fund are subject to scrutiny as it involves a huge amount as well as an appetite for risk. Financial managers are always quizzed about the possibility of tax evasion, deduction and payment. The reason for the numerous questions and no uniformity in the answers of the financial experts is due to difference in treatment of mutual fund returns and different ways of calculating its tax liability.

The profit or returns earned from mutual funds are taxed under the category of 'Income from Capital Gains.' Capital gains can be short-term or long-term and this division is based on the holding period of investments. Tax rates are definitely different for both with the rules of capital gains differing for equity as well as non-equity schemes.

There is too much information to be processed, so get ready for it.


Taxation: Equity Schemes

Mutual fund schemes that invest 65% of their total corpus into equity instruments are subjected to taxation under the equity scheme provision. If an equity mutual fund is held for more than a year than the returns from that equity mutual fund are taxed under long term capital gains. The current income tax laws have exempted such returns completely from the burden of paying income tax.

Returns held for less than a year or a year are treated under the short-term gain and the returns from the same are taxed at a rate of 15%.

Taxation: Debt Schemes

Mutual fund schemes that do not invest more than 65% of the corpus in equity are termed non-equity funds and they are taxed separately. Debt mutual funds are within the ambit of this category. Gold funds, fund of funds, international funds too are categorized as non-equity schemes when it comes to taxation.

The returns of non-equity funds that have been held by the investor for more than three years are treated under long-term capital gains and the returns are taxed at 20 per cent with the indexation benefit.

What is Indexation?

It is a process by which the purchase cost is inflated to account with the help of a price index. By indexation an investor achieves a relief from taxable profits.

Investments that are held for less than three years or three years than the returns on the mutual fund scheme is considered under short-term capital gains. Such gains are added to the income and they are taxed as per the income tax rate applicable.

Taxation: Hybrid Schemes

Hybrid schemes can be either equity-oriented or debt-oriented. Before the initial investment in the equity, the information document would provide details on the specific investment pattern, making it clear for the investor that the mutual fund scheme is an equity fund or a debt fund.

Investors are expected to pay close attention to details in the terms and conditions while opting for investment in hybrid scheme because the tax liability differs from the above two described earlier.

Calculating the Holding Period

The date of purchase or investment in the mutual fund till the day it is sold is classified as the holding period. In case of a Systematic Investment Plan (SIP), an investor purchases certain units or shares of the scheme every month or quarter and the holding period for all of these need to be calculated individually.

Calculating the Taxed Dividends

Investors often invest in a mutual fund scheme under the dividend option. Investors under this option receive annual dividends and are not liable to pay any tax on them as they are exempted from income tax in both equity as well as the debt investment scheme. Though an individual investor is not taxed on dividends, mutual fund houses before declaring the dividends pay a distribution tax of 28.84%.

Have Referral Code?