Those who know what is a mutual fund realise how it can help them grow wealth effectively. When you invest in mutual funds, you can earn income in the form of capital gains or dividend. But, where there is income, there can be a tax. Whether you invest in equity funds or debt funds, you need to pay a tax depending on the time you hold it. This is also known as the holding period.
Here is what you ought to know about mutual fund investment and taxation on mutual funds.
Equity mutual funds
- Long Term Capital Gains (LTCG)
Any capital gains from equity funds held for more than 12 months are treated as LTCG. The tax rate is 10% if those capital gains exceed Rs. 1,00,000 in a financial year.
For example, Mr. X invested Rs. 40,000 on 1st Jan 2018 and redeemed on 1st Feb 2019, where he received Rs. 65,000. Since the capital gains are less than Rs. 1,00,000, he does not need to pay tax. However, if he stays invested for 4 years and redeems when his investment is Rs. 2,20,000, the capital gains are Rs. 1,80,000. Mr. A would need to pay tax on the amount exceeding Rs. 1,00,000 i.e. 80,000 @ 10% = Rs. 8,000.
- Short Term Capital Gains (STCG)
Any capital gains from equity funds held for less than 12 months are treated as STCG. These gains are taxed at 15%.
Debt mutual funds
- Long Term Capital Gains
Any capital gains from debt mutual funds held for more than 36 months are treated as LTCG. The gains are taxed at 20% after providing the indexation benefit.
For example, Mr. B invested Rs. 2,00,000 for more than 36 months in a debt fund in 2013. In 2018, he redeemed his investment at Rs. 2,50,000. Here is how the tax would be calculated after indexation.
Original Investment (2013) Rs. 2,00,000
Redemption Amount (2018) Rs. 2,50,000
Capital Gains Rs. 50,000
Indexation Benefit (240/200) * 2,00,000 Rs. 2,40,000
Adjusted capital gains Rs. 10,000
Tax @20% Rs. 2,000
Where formula for indexation benefit is:
Cost Inflation Index for the year of the sale
Cost Inflation Index for the year in which asset x Cost of acquisition
was first held by the assessee
- Short Term Capital Gains
Any capital gains from debt mutual funds held for less than 36 months are treated as STCG. So, if profits are added to your income, the tax rate would depend on the income slab you fall in.
For example, if you are in the 30% income tax bracket and have an STCG of Rs. 20,000, it will be added to your income, and you will be taxed 30% on Rs. 20,000 i.e. Rs. 6,000.
Thus, before you invest in different types of mutual funds you may want to compare taxation on equity funds v/s debt funds to understand how each one is taxed differently. This can help you maximise your earnings from mutual fund investment plans and realise your financial goals.