Things you need to know about Taxation in Mutual Funds (Detailed)
Things you need to know about Taxation in Mutual Funds: Mutual Funds have turned out to be one of the best investments in recent times. With the experts building the portfolios, the returns have grown to a great extent and common man has enormously benefitted from it. As compared to Recurring or Fixed Deposits which provide very low returns (and which are becoming lower and lower with time), Mutual Funds and Trading in the stocks gives great results.
Earning money is important and equally important is saving tax on these investments. So, we will have a look on how Mutual Funds are taxed.
We can earn from Mutual Funds in two ways:
- Dividend Returns
- Growth Returns
Dividend Returns imply the dividend which we receive periodically from our stocks. The basic difference between Dividend Returns and Growth Returns is that in Growth Returns, the dividend is reinvested in the securities to earn more returns. This implies that there is a short term income in Dividend Returns while there is no such income received in hand in case of growth funds.
Thus, Growth Funds are for long term while Dividend Funds are for short term benefits. Let us have a look on the taxability of the same.
Dividend on Mutual Funds is always exempt. The reason for this is that Tax is already paid by the company before the distribution of dividend. So, the dividend received by the shareholders is Post Tax.
Tax on Equity Mutual Funds:
Also, Equity Schemes are classified into Equity Linked Savings scheme or others. In ELSS, the portfolio contains 65% or more of its holdings in domestic shares. If such units are held for a period of more than 12 months, then they qualify as Long Term Holdings and are tax-free! Yes, you read it right, Tax Free!
However, if the units are held for a period of less than 12 months, they are short term assets and thus Short Term Capital Gain arises and tax needs to be paid @15% on the Gains.
Tax on Non – Equity Mutual Funds:
Non-equity mutual funds include liquid funds, money market funds, debt funds and infrastructure debt funds. Here, if the units are held for a period of more than 36 months, they are classified as a Long Term Asset while if it held for a period of less than 36 months, they are classified as Short Term Asset.
In case of Long Term Mutual Funds, the tax rate is 20% along with indexation benefit and if a unit holder doesn’t opt for indexation, then the tax rate is of 10%. Indexation, in case you are unaware, is assigning the time value benefit to the Asset. This is because money has a time value. The thing that you must have bought for a 100 bucks 3 years earlier, will not cost the same now and will cost even more after 3 years. This is the reason indexing is done so that the cost price of the asset whose gain is being calculated is in accordance with the present times.
When the Asset is held for a period of less than 3 years from the date of allotment, Short Term Cap Gain is applicable on the said transaction. Also, as per the current tax slabs, if our taxable income is less than 2.5 Lakhs, then no tax will be applicable on the said transaction. For people having taxable income between 2.5 Lakhs to 5 Lakhs, tax applicable will be 5% of debt fund gains. However, tax rate applicable will be 20% in case of Assessee having higher incomes.
Taxation of International Funds:
International Funds are the investments in stocks of various International Companies. The classification is done into Long Term & Short Term and their taxability is also similar as above. Short Term Capital Gain or Long Term Capital Gain is calculated as per the rules of Taxation of Debt Funds as above.
Taxation of Hybrid Mutual Funds:
The funds which include both Equity stocks and debt funds are called as Hybrid Mutual Funds. Their taxation is a little ambiguous. If 65% or more of these funds are equity investments, then tax will be applicable to them as described for Equity Linked Savings Scheme earlier. However, if the proportion of equity is less than 65%, the same will be taxed in the way in which Debt Funds are taxed.
So, in this article, we have covered the general taxability rules which are applicable to the mutual funds. However, to know the exact status of taxation of a particular fund, we need to know the exact composition of that fund. As a personal advice of the writer, it is always better to get a clear picture of the taxability of a fund prior to investing, so that there are no hassles later on!