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Chapter 9 Taxation on Mutual Funds

Taxation on Mutual Funds

Mutual funds offer a range of tax benefits that an investor should consider in tax planning.

Equity Funds (Including equity-oriented balanced fund)

Dividends and long-term gains from equity and balanced funds (that have 65% or more of their assets invested in equity) are tax free for the investor. Profits earned on Mutual Fund investments, for a period less than one year, are taxed at 15%. It is known as short-term capital gains tax.

Equity Products Enjoy Tax Benefits

  • ELSS gets an income tax deduction of Rs. 150,000, under Sec 80 C.

  • STT is not applicable on MF purchases, unlike in direct trading.

Debt Oriented Funds

Short-terms gains in debt oriented funds are taxed at one’s personal income tax rate. If one comes under the lowest tax bracket, the person pays 10% tax on the gains for a period of less than 3 years. For long-term gains (holding period > 3 years), tax is 10% without indexation and 20% with indexation benefit.

What is Indexation Benefit?

When a debt mutual fund is held for more than 3 years, the investor is allowed to index ones entry price to inflation i.e. increase the entry price by the rate of inflation in the economy over the past 3 years. This higher entry price is used to calculate profit for tax purposes (it results in lower tax liability). This is unlike FDs where the entire income is taxed at personal tax slabs of up to 30%.

Taxation on Mutual Funds for Individual/HUF (2016-17)

Capital Gains Taxation

Equity Oriented Funds Tenor Individual/HUF$
Long term capital gains Units held for more than 12 months NIL
Short term capital gains Units held for 12 months or less 15%
Debt Oriented Funds Tenor Individual/HUF$
Long term capital gains Units held for more than 36 months 20%&
Short term capital gains Units held for 36 months or less 30%^
$ Surcharge at 15% to be levied in case of individual/ HUF unit holders where their respective income exceeds Rs 1 crore. & After providing indexation. ^ Assuming the investor falls into highest tax bracket. $ Education Cess at 3% will continue to apply on aggregate of tax and surcharge.

Taxation on Dividend (Payable by Investor/HUF)

Tenor Individual/HUF
Equity oriented schemes Debt oriented schemes
NIL NIL

Dividend Distribution Tax (payable by the MF schemes)

Scheme Type Individual/HUF
Equity oriented schemes NIL
Debt oriented schemes 25% + 12% Surcharge + 3% Cess = 28.84%

Key Takeaways

  • Long term capital gains from equity funds are tax free while there is tax of 15% on short term capital gains from equity funds.

  • Short-term capital gains from debt investments add to the income of the investor and taxed as per his tax bracket of the investor whereas long-term capital is taxed at 20% after indexation.

  • Capital gains from equity funds and debt funds are considered long-term if the investment horizon if more than 1 year and 3 years respectively.

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