Taxation on Mutual Funds

What Are Mutual Funds?

A pooled sum of money collected from several investors is known as a mutual fund. Depending on the kind of mutual fund, it is invested collectively in a variety of financial assets, such as equity funds, debt funds, real estate, etc.

You purchase shares directly from the company when you invest in the stock market. However, when you invest in mutual funds, you do so in an asset management company, which then invests your funds in a variety of assets to provide you with a diversified portfolio. Each mutual fund is overseen by a qualified fund manager with years of experience and in-depth financial understanding. These fund managers conduct an in-depth analysis of extensive statistical data prior to making investments.

Let’s say you contributed INR 10,000 to a mutual fund. The returns won’t be as great as you hope if you’re the only one investing a small sum. But in a mutual fund, there are many investors like you who each make a comparable amount of investment, resulting in a big money pool. This huge corpus is given to an asset management company, which pools the money and invests them in securities including equities, bonds, and short-term debt.

How Do You Earn Returns In Mutual Funds?

Dividends and capital gains are two alternative methods to profit from mutual fund investments. Based on their market earnings, the stock investment funds pay dividends. You get this sum if you decide to accept these dividends. However, many asset management companies will provide you a second choice, allowing you to reinvest your earnings and use the power of compounding to build your money.

Capital gains are another way to generate income. This is comparable to the stock market, where you purchase mutual fund units for a specific price and then sell them at a profit when the value of your units rises in the future.

Taxation Of Dividends Offered By Mutual Funds

A dividend mutual fund invests largely in companies that pay dividends. These dividends are mostly earnings that companies provide to stockholders/shareholders. Profits are made by selling the equities at a greater price than when they were obtained. These gains are added to the Net Asset Value (NAV) by the asset management company (AMC). However, AMCs cannot include unrealized earnings (profits that are still on paper) from dividend-paying instruments. They sometimes declare a part of unrealized profits as dividends, and this choice is made by the fund manager. The asset manager may also use the funds to purchase equities or debt instruments in accordance with the scheme.

Dividends from mutual funds were tax-free in the hands of investors until March 31, 2020. (FY 2019-20). This was due to the fact that the company declaring dividends paid dividend distribution tax (DDT) prior to making the dividend payment. The Finance Act of 2020, on the other hand, altered the system of dividend taxes.

Because the DDT on dividends was repealed, any dividends paid on or after April 1, 2020, will be taxable in the hands of the investors. The Finance Act, 2020 also levies a TDS on mutual fund dividend distributions made on or after April 1, 2020. TDS is levied at a regular rate of 10% on dividend income in excess of Rs 5,000 received from a company or mutual fund.

As a COVID-19 relief measure, the government reduced the TDS rate for distribution from 14 May 2020 to 31 March 2021 to 7.5%.

Form 15G/15H Submission:

Form 15G can be submitted to the mutual fund house paying the dividend by a resident individual receiving dividends whose expected annual income is less than the exemption limit.

Similarly, a senior citizen whose anticipated yearly tax payable is nil might file Form 15H with the company that is receiving the dividend. The mutual fund sends the dividend declaration to the shareholder’s registered email address and needs the filing of form 15G or form 15H to collect dividend income without TDS. Depending on their investment objectives, investors can select either the growth or dividend option. People who want to develop their wealth over time normally choose the growth option, because the compounding effect is lost when AMC provides dividends.

Taxation of Capital Gains Offered By Mutual Funds

The amount of tax you pay on capital gains from mutual funds depends on the kind of mutual fund scheme you participate in and how long you’ve owned the scheme’s units. Based on this, let’s examine the two elements in more depth.

Let’s start out by discussing what the terms long-term capital gains (LTCG) and short-term capital gains (STCG) signify. The capital gain from an asset that an investor retains for a long time, or a long holding period, is called LTCG, whereas the capital gain from assets kept for a relatively short time is called STCG.

For tax purposes, the words “long duration” and “short duration” refer to different equity and debt schemes. For example, if you own equity-oriented mutual funds, your holding time must be at least 12 months; if you own debt-oriented mutual funds, it must be 36 months.

Taxation on Equity-Oriented Mutual Funds

Gain Type	Holding Period	Tax Rate
Short Term Capital Gain	Less Than 1 year	15%
Long Term Capital Gain	More Than 1 year	Capital Gain < 1 lakh Tax-Exempt Capital Gain > 1 lakh Tax rate- 10%

Taxation on Hybrid Mutual Funds

Type of Mutual Fund Scheme	Gain Type	Holding Period	Tax Rate
Hybrid Mutual (equity exposure more than 65% of total investment)	LTCG	More than 12 months	10% over and above Rs. 1,00,000 without indexation
Hybrid Mutual (equity exposure more than 65% of total investment)	STCG	Less than 12 months	15%
Hybrid Mutual (equity exposure less than 65% of total investment)	LTCG	More than 36 months	20% with indexation
Hybrid Mutual (equity exposure less than 65% of total investment)	STCG	Less than 36 months	The capital gain to be added to the gross total income taxed at normal slab rate

Taxation on Debt Mutual Funds

Gain Type	Holding Period	Tax Rate
Short Term Capital Gain	Less Than 36 Months	Applicable tax income tax rates
Long Term Capital Gain	More Than 36 Months	20% with indexation

Taxation of Capital Gains When Invested Through SIPs

The SIP receives no preferential tax treatment. It solely takes into account whether the underlying fund on which the SIP is based is an equity fund or a debt fund. Here are the key points of how SIPs will be taxed.

SIPs in equity funds are taxed as LTCG if held for more than one year and as STCG if kept for less than one year from the date of acquisition. This will apply to each purchase tranche separately for SIPs.

SIPs on non-equity (debt and other categories) funds are taxed as LTCG if held for more than three years and STCG if kept for less than three years from the purchase date. In the case of SIPs, this will apply to each individual purchase tranche.

Long-term capital gains on stock funds would be taxed at 10% after a base exemption of Rs.1 lakh, however, indexation will not be available. Short-term stock capital gains will be taxed at 15%. In both circumstances, the relevant surcharge and cess will be charged.

Long-term capital gains on debt funds will be taxed at 20% plus indexation. Short-term capital gains from debt funds will be included in income and taxed at the highest marginal rate. In both circumstances, the relevant surcharge and cess will be charged.

Securities Transaction Tax(STT)

The security transaction tax is a tax on capital gains derived from dealing with securities such as stocks, options, and futures.

So, STT tax is a direct tax levied and collected by the central government on all domestic equity, option, and futures transactions. It was implemented in 2004 as an enhanced technique to streamline capital gain reporting and tax collection in order to prevent tax evasion. Its features are comparable to TDS (tax deducted at source), which is imposed when a transaction occurs, such as when you sell or buy a share.

The Securities Transaction Tax Act (STT Act) governs the management of STT. It also includes information on how STT is calculated, who is responsible for paying it, and a list of financial products that qualify for STT.

STT is gathered in the same manner as TCS and TDS. That is, it is deducted at the source. STT is received by the stock exchange and deposited with the government for capital market transactions. It is filed with the AMC for mutual funds, and it is collected by the merchant bank designated by the company for IPOs.

Securities Transaction Tax(STT)

STT is imposed on the following types of investment instruments, as defined by the Securities Contract (Regulation) Act of 1956.

Stocks, debentures, bonds
Derivatives
Equity Mutual Funds
Any other marketable securities
Government securities that function like equities
Interests earned on securities
Units issued by any collective schemes to investors,

However, STT doesn’t apply to

Private or off-market transactions
Debt and debt funds, and
New Fund Offers (NFOs)

STT Tax Rates

STT rates are determined by the underlying asset’s kind and volume. The government sets the rates, which are periodically updated. STT may apply to both buyer and seller, or seller or buyer, depending on the financial instrument exchanged.

STT Tax Rates

Following are the taxable security transactions:

Security Type	Transaction Type	STT Rate	STT Levied On
Equity	Buy (Delivery)	0.10%	Purchaser
Equity	Sell (Delivery)	0.10%	Seller
Derivatives- Future	Buy	Nil	–
Derivatives-Future	Sell	0.01%	Seller
Derivative-Option	Buy	Nil	–
Derivative-Option	Sell	0.05%	Seller
Derivative-Option (When Option is exercised)	Sell	0.125%	Purchaser
Equity Mutual Funds	Buy	Nil	–
Equity Mutual Funds- Close Ended/ ETF	Sell	0.001%	Seller
Equity Mutual Funds- Open Ended	Sell	0.025%	Seller
Equity Mutual Funds-Intraday (Non-Delivery)	Sell	0.025%	Seller

STT and Capital Gains Tax Reporting

When you invest in assets for the purpose of profit, you must pay capital gains tax. Long-term capital gains and short-term capital gains are the two forms of capital profits. Similarly, there are losses suffered as a result of exchanging assets at a lower price than their purchase price. STT has no effect on capital gains tax. It cannot be claimed as an acquisition cost or used with a capital loss to offset a capital gain.

The exception is when you trade stocks professionally. Then, trading income is taxed at income tax rates, and STT paid on stock revenue can be reimbursed under Section 36 of the Income Tax Act.

Conclusion

Mutual fund taxation isn’t as difficult as one may believe. The taxes of mutual funds is largely determined by the holding duration and whether the scheme is equity or debt-oriented. It may be stressful to have to manually compute everything when the return filing deadline is only a week away.

FAQs

Am I subject to paying tax on mutual funds?

During the sale of mutual fund units, capital gains will be generated. In India, this capital gain is thus liable to capital gains tax. The tax can be paid as an advance tax before the end of the fiscal year.

Am I subject to paying tax on mutual funds?

To avoid capital gains tax on mutual funds in India, you must carefully arrange your taxes and unit redemptions. Before redeeming mutual fund units, you must determine your capital gain and tax liability. To reduce your tax liability, you can invest in investments that qualify for tax deductions. LTCG on equities funds held for more than 12 months is exempt up to Rs 1 lakh. Consequently, you may plan your investments appropriately. In addition, the STCG on borrowed funds is taxed at a slab rate. If your taxable income is less than the exemption threshold, your STCG on borrowed funds will be entirely tax-free.

Is Security Transaction Tax refundable?

STT (Security Transaction Tax) is not refundable. Furthermore, STT cannot be claimed as part of the acquisition cost, nor will it lower the capital gains tax due. The long-term capital gains tax (LTCG) on equities is 10% (above Rs. 1 lakh), while the short-term capital gains tax (STCG) is 15%. It can, however, be claimed as a business expenditure as well as other taxes and penalties by individuals (professional traders) who trade in mutual funds, shares, or F&O.

How much are mutual funds taxed?

The tax rate on mutual funds varies based on the kind of income, plan, and holding duration. Up to Rs 1 lakh of LTCG on equity plans is free from tax. LTCG in excess of Rs 1 lakh is taxed at a 10% rate. STCG on equity plans is subject to a 15% flat tax rate. In addition to the indexation benefit, long-term capital gains on debt funds are subject to a 20% tax rate. STCG on debt funds is taxed at the rate applicable for the appropriate fiscal year.

Which ITR should I use to report my capital gains?

Individual taxpayers must submit ITR-2, ITR-3, or ITR-4 for capital gains tax. ITR-5 applies to taxpayers who are neither individuals nor corporations. ITR-6 and ITR-7 apply to corporations. Read this post to learn more about which ITR is suitable based on income and kind of taxpayer.

Is the 1 lakh capital gains exemption accessible to all taxpayers?

Yes, the Rs 1 lakh tax exemption on long-term capital gains from equity-oriented mutual fund schemes applies to all taxpayers.

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Taxation Of Mutual Funds