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Chapter 1 Introduction to Mutual Funds

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module 10 | What are the tax implications of investing in Mutual Funds?

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

Equity Oriented Funds

Dividends and long-term gains from equity and balanced funds (that have 65% or more of their assets invested in equity) are tax free in the hands of the investor. Profits earned on MF 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 80C.
Rajiv Gandhi Equity Savings Scheme (RGESS) offers 50% deduction on investments up to Rs. 50,000, if annual income is < Rs. 12 lacs.
STT is not applicable on MF purchases, unlike in direct trading.

Short or Long

The holding period for tax treatment between equity oriented (>= 65% in equities) and debt products is different. In case of equity, short-term refers to holding period less than 1 year, while for debt funds, it means holding period of less than 3 years.

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, she 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 her 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 (this results in lower tax liability). This is unlike FDs where the entire income is taxed at personal tax slabs of up to 30%.

FD Versus MF Benefits

Debt MFs are taxed at 20% after indexation, while Bank FDs are taxed in line with the investor’s marginal tax rate. So, if one belongs to the higher tax brackets (20% or 30%), MF is a better investment than an FD.