Introduction – What Are Mutual Funds?
Investors have a variety of investment options at their disposal these days. One of the popular investment choices is to invest in mutual funds. Mutual funds also involve some dangers, just like any other investment class. When making investment decisions, investors should analyze the risks and anticipated returns on various instruments after accounting for tax. When making investing selections, investors may consult with experts and consultants, including representatives and distributors of mutual fund schemes.
An effort has been made to give information in a question-and-answer manner that may aid investors in making investment decisions with the goal of educating them on how mutual funds operate.
Mutual Fund – How Does It Work?
Mutual funds are a vehicle for pooling resources. By issuing units to investors and investing money in securities in accordance with the objectives stated in the offer document, they allow individual investors to benefit from professional management of money.
The risk for investors is decreased since investments in securities are diversified over a diverse range of industries and sectors. Because not all stocks will move in the same way at the same time, in the same amount, diversification lowers risk. According to the amount of money deposited by the investors, mutual funds issue units to the investors. Unitholders are individuals who invest in mutual funds.
The mutual fund houses typically release a number of schemes with various investment objectives that are introduced periodically. Before receiving contributions from the general public, a mutual fund must register with the Securities and Exchange Board of India (SEBI), which oversees the securities markets.
What Is The History Of Mutual Funds And SEBI In India?
The first mutual fund to be established in India was Unit Trust of India in 1963. Early in the 1990s, the government approved the establishment of mutual funds by public sector banks and institutions.The Securities and Exchange Board of India (SEBI) Act was passed in the year 1992. Protecting the interests of investors in securities as well as fostering the growth and regulation of the securities industry are the goals of SEBI.
As far as mutual funds are concerned, SEBI develops regulations and policies to safeguard investors’ interests. In 1993, SEBI published rules for mutual funds. Mutual funds supported by companies in the private sector were then permitted to access the capital market. The rules were completely updated in 1996, and since then, they have occasionally been changed. In order to safeguard investors’ interests, SEBI periodically issues recommendations to mutual funds.
The same set of regulations applies to all mutual funds, whether they are promoted by public sector or private sector organisations, including those that are sponsored by foreign organisations. These mutual funds are all subject to SEBI supervision and inspections, and there are no differences in the regulatory rules that apply to them.
What Is The Structure Of A Mutual Fund?
A trust that has a sponsor, trustees, asset management company (AMC), and custodian is used to set up a mutual fund. A sponsor, or more than one sponsors who act similarly to a company’s promoters, establishes the trust. For the benefit of the unitholders, the mutual fund’s trustees hold its assets in the trust. The funds are managed by an Asset Management Company (AMC) that has received SEBI approval and makes investments in a variety of assets. Securities from the fund’s various schemes are held in the custody of the custodian, who is registered with SEBI. The trustees are given broad supervision and management authority over AMC. They keep an eye on the mutual fund’s performance and compliance with SEBI regulations.
According to the SEBI regulations, at least two-thirds of the trustee company’s or board of trustees’ directors must be independent, which means they cannot be connected to the sponsors. Additionally, at least half of the AMC’s directors must be independent. Before launching any plan, mutual funds must first register with SEBI.
Let us now understand how mutual funds are taxed before we understand what tax harvesting is.
What Are The Kind Of Returns You Can Get From Mutual Funds?
Dividends and capital gains are the two types of gains, offered to investors by mutual funds.
If an investor sells a security, they own, for more money, they will have realised a capital gain. In plain English, capital gains are realised as a result of an increase in the price of mutual fund units. When mutual funds have extra cash on hand, they may choose to distribute it to investors as dividends. Investors earn dividends in proportion to the number of units they own in mutual funds. Investors in mutual funds must pay taxes on both dividends and capital gains.
How Are Dividends Taxed?
The Union Budget 2020 made changes that affect how dividends offered by any mutual fund plan are taxed. In other words, dividends that investors receive are added to their taxable income and taxed at the rates applicable to an individual’s income tax slab. Dividends were previously exempt from tax in the hands of investors since businesses paid dividend distribution tax (DDT) before distributing their profits to investors as dividends. Investors were not subject to tax on dividends (received from domestic enterprises) up to Rs 10 lakh per year during this era. Any dividends that exceeded Rs 10 lakh per fiscal year were subject to a 10% dividend distribution tax.
How Are Capital Gains On Mutual Funds Taxed?
The holding duration and kind of mutual fund affect the tax rate on capital gains for mutual funds. The holding period is the length of time an investor held units of a mutual fund. The holding period, put simply, is the span of time between the date of buying and selling mutual fund units.
How Are Capital Gains On Equity Mutual Funds Taxed?
Mutual funds classified as equity funds have an equity exposure of at least 65 percent. As previously stated, when you redeem your equity fund units during a holding period of one year, you realise short-term capital gains. Regardless of your income tax status, these gains are taxed at a flat rate of 15%.
When you sell your stock fund units after holding them for at least a year, you realise long-term capital gains. These capital gains are tax-free up to Rs 1 lakh each year. Any long-term capital gains that surpass this threshold are subject to LTCG tax at a rate of 10%, with no benefit of indexation.
How Are Debt Mutual Funds Taxed?
Mutual funds that have a portfolio debt exposure of more than 65 percent are considered debt funds. If you redeem your debt fund units during the first three years of holding them, you will receive short-term capital gains. These gains are included in your taxable income and taxed at the rate specified by your tax bracket.
When you sell units of a debt fund after three years of owning them, you realise long-term capital gains. After indexation, these profits are taxed at a flat rate of 20%. Additionally, you must pay any applicable cess and surcharge on tax.
Taxation of Capital Gains Made Through SIP Investments
Mutual fund investments can be made using systematic investment plans (SIPs). They are made so that investors can regularly invest a little sum in a mutual fund programme. Investors have the option of selecting the frequency of their investments. Weekly, monthly, quarterly, bi-annually, or annually are all viable options. With each SIP instalment, you buy a set amount of mutual fund units. These redemptions are handled on a first-in, first-out basis. Consider making a one-year SIP commitment in an equities fund, then choosing to reinvest the entire amount after 15 months. In this instance, you realise long-term capital gains on the SIP-first purchased units since you hold them for an extended period of time (more than a year). You are exempt from paying tax on long-term capital gains that are less than Rs. 1 lakh. However, if you sell your mutual funds units in the second month, you realise short-term capital gains on the units acquired through SIPs. No matter what income tax bracket you are in, these gains will be taxed at a flat rate of 15%. You must cover the relevant cess and surcharge for it.
What Is Securities Transaction Tax?
The Securities Transaction Tax (STT) is a separate tax from the capital gains and dividend tax. When you choose to acquire or sell equity oriented mutual fund units on a stock exchange, STT at the rate of 0.001 percent is applicable on the transaction.
Tax Harvesting: What Is It?
Selling and buying the same investment in order to realise or “harvest” the returns is known as tax harvesting. As a result, one can reduce their tax obligation and boost their post-tax returns by offsetting the gains against losses or exemption limits. Let’s examine this idea from the viewpoint of someone who has equities mutual funds invested in the Indian stock market. Before this person considers tax harvesting, there are three very crucial points to keep in mind:
- His mutual fund investments should be held for a minimum of twelve months before being sold (which is the definition of long term duration).
- His holding should increase in value over time, resulting in a long-term capital gain.
- Brokerage fees and transaction costs should be kept to a minimum. If these fees are large, moving mutual funds will become more expensive and have less impact on tax harvesting.
Understanding The Math Of Tax Harvesting
Selling the units that are eligible for LTCG and then purchasing them again at the going rate is the fundamental concept behind LTCG tax harvesting. As a result, your acquisition cost for intermittent units rises, which lowers the LTCG rupee amount in the redemption year but has no effect on the asset’s final value. Essentially, in simple terms, you should sell your mutual funds units at the end of the year and book long term capital gains upto 1 lakh as they are tax exempt. Thereafter, you should immediately buy the mutual fund units back and continue this cycle.
When Should You Make Tax Harvesting Plans?
Once your equities or mutual fund has been held for more than 12 months, whether in full or in part, you should think about harvesting. Investments that have a duration of less than 12 months are not eligible for long-term capital gains tax exemption. In fact, it will result in a 15 percent STCG, which is a significant amount. Additionally, some mutual funds change a fee known as ‘exit load’ when you sell the mutual fund units, so it is very important that you read the offer document of your mutual fund carefully and determine if there is any exit load and take a decision in respect of selling the mutual fund units only after taking in account the exit load.
How Can LTCG Tax Harvesting Be Planned?
You can also carry out tax harvesting on your own if you’re a do-it-yourself investor. However, as the number of assets in your portfolio grows, keeping track of every transaction and figuring out which ones qualify for LTCG exemption may take more work.
Kuvera takes care of this for you, so you don’t have to worry. Read on to know more.
How do I do Tax Harvesting on Kuvera
Kuvera offers the best tax harvesting feature for its investors to help minimise long term tax impact. Using advanced algorithms, Kuvera helps you realise up to ₹1 lakh of long term capital gain (LTCG) every financial year with no tax. This way, you can save upto ₹10,000 in LTCG taxes every financial year.
To avail tax harvesting, you just need to activate Tax Harvesting in your Kuvera account. After that, Kuvera will monitor your portfolio and give you on-time recommendation of transactions to be made. Just follow the recommendations and you are done!
Click here to know more about Tax Harvesting on Kuvera.
On the surface, LTCG tax harvesting savings could appear insignificant. However, when your portfolio expands and the period of wealth generation lengthens, these modest sums can easily add up to substantial sums. It makes perfect sense to harvest your gains from stock investments, notably mutual funds, if the tax on long-term capital gains is going to be around for a few more years.
Frequently Asked Questions:
Can tax harvesting be done in case of short term capital gains?
No, tax harvesting can be undertaken on long term capital gains.
How much money can I save through tax harvesting?
You can save upto a minimum of INR 1 lakh through tax-harvesting.
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