0 hidden charges. 0 forex
debit-card

Tax Implications of Mutual Funds

FACT CHECKED
Reviewed by
.
Created on
July 25, 2022

Summary

What’s Inside

What are the tax implications of investing in mutual funds? It is a question I frequently come across online. Okay, first, let’s get one thing straight. In India, you have to pay a tax when you earn a profit either by doing business, selling any commodity or even getting returns from your investments. And mutual funds are no exception to this rule. 

Taxes paid on mutual funds can get a bit confusing since there are multiple points to remember like type of fund, duration of investment, tax slab etc. Allow us to simplify this for you.

Let’s start with understanding the earnings from mutual funds

There are two main ways to earn by investing in a recognised mutual fund. 

Earnings from dividends

Certain mutual funds offer a dividend payout component, meaning you can earn from the dividends issued by the stocks in the mutual fund you invested in. The dividend is received in proportion to the number of shares you hold via the mutual fund.

Tax implications of dividends

Previously, dividends were tax-free as companies paid Dividend Distribution Tax (DDT). Dividends up to ₹10 lakh were exempt, and above that, a 10% DDT applied. However, the 2020 Union Budget changed the rules. Dividends are now taxed as part of your taxable income. If dividends exceed ₹5,000, a 10% TDS is applied, or 20% if PAN and Aadhaar are not linked.

Earnings in the form of capital gains

The profit you earn after selling an asset at a higher price than what you initially bought is known as a capital gain. Suppose you buy units at ₹1000 and they generate a return of 10%. After some time, the value of your units will be ₹1100, and if you sell the units, then ₹100 earned is taxable.

Tax implications of capital gains 

Capital gains are taxable only after the asset is sold. For making calculations simpler, mutual funds are categorised below.

Fund Type

Short-Term Capital Gains

Long-Term Capital Gains

Equity Funds

Less than one year

Over one year

Debt Funds

Less than three years

Over three years

Hybrid Equity oriented Funds

Less than one year

Over one year

Hybrid Debt oriented Funds

Less than three years

Over three years

 

Fund Type

Short-Term Capital Gains (STCG)

Long-Term Capital Gains (LTCG)

Equity Funds

15% + surcharge + cess

Up to ₹1 lakh a year is tax-free. Beyond that is taxed at 10% 

Debt Funds

Taxed based on income tax slab

20% + surcharge + cess

Hybrid Equity oriented Funds

15% + surcharge + cess

Up to ₹1 lakh a year is tax-free. Beyond that is taxed at 10% 

Hybrid Debt oriented Funds

Taxed based on income tax slab

20% + surcharge + cess

Securities Transaction Tax (STT)

Apart from the above LTCG and STCG tax, a 0.001% Securities Transaction Tax is levied by the government when units of an equity fund or hybrid equity-oriented funds are sold. It is very similar to Tax Deducted at Source (TDS). Having STT helps keep a tab on taxpayers from evading taxes by not disclosing the profit from the sale of these units.

Are SIP’s an exemption from tax?

In short, no. A Systematic Investment Plan or SIP allows you to invest a particular sum every month or quarter in a mutual fund scheme. Suppose you invest in a mutual fund scheme, and after 13 months, you withdraw them. Since these funds are held for more than one year, you will get long-term capital gains. If the gains are less than ₹1L, you don’t have to pay tax.

If you withdraw before 12 months, you will receive short-term capital gains taxed at 15% + surcharge + cess, irrespective of your income tax slab.

In a nutshell

Just keep in mind that the longer you stay invested, the better it is. The tax implications of investing in mutual funds may seem intimidating at first, but it begins to make more sense as you keep investing. As the adage goes, Rome wasn’t built in a day.

All you need to ensure is that you’re clear on your goals, read the products carefully, and do your homework. You can always take the help of Fi’s online calculators before taking the final plunge. Explore other in-depth Fi Money calculators here. 

Frequently Asked Questions

1. Is income from a mutual fund taxable?

Mutual fund dividends exceeding ₹5,000 are subject to a 10% TDS, or 20% if PAN and Aadhaar are not linked. Long-term capital gains tax applies to assets held for a specific period, e.g., stocks and bonds for over 1 year, gold for over 3 years. Short-term capital gains tax is levied on profits from the sale of assets held for a short period. Additionally, a 0.001% Securities Transaction Tax is charged when selling units of equity or hybrid equity-oriented funds.

2. How much tax do you pay on mutual fund withdrawal? 

The rule of the game is to stay invested longer. The longer you hold your mutual funds, the more tax efficient they become.

  • Equity Funds

STCG: 15% + surcharge + cess
LTCG: Up to ₹1 lakh a year is tax-free. Beyond that is taxed at 10% 

  • Debt Funds

STCG: Taxed based on income tax slab
LTCG: 20% + surcharge + cess

  • Hybrid Equity-oriented Funds

STCG: 15% + surcharge + cess
LTCG: Up to ₹1 lakh a year is tax-free. Beyond that is taxed at 10% 

  • Hybrid Debt oriented Funds

STCG: Taxed based on income tax slab
LTCG: 20% + surcharge + cess

Note: 

STCG stands for Short-Term Capital Gains
LTCG stands for Long-Term Capital Gains

3. Are all mutual funds tax-exempt?

No. Mutual funds are not tax-exempt. Like all things, you have to pay taxes if you earn a profit on your investments. The good thing is that mutual funds, when used right, are tax efficient. Plus, there are mutual funds that help you save on income tax

  • ELSS: Planning to dabble in mutual funds for tax-saving benefits? Check Equity Linked Saving Schemes (ELSS). Unlike other equity funds, it enables you to invest in stocks while remaining eligible for tax deductions (upto ₹1.5 lakh)! The caveat here is a 3 year lock-in period.
  • ULIP: It's insurance + investment! Here part of the premium paid gets invested (as per choice) & the rest becomes part of an insurance policy. Unit Linked Insurance Plan (ULIP) also offers tax benefits! Sounds like a winner, right? Before opting in, dig deeper into the fees.

4. Do we need to show mutual funds in ITR?

Individuals who earn capital gains during a financial year are required to declare their earnings through mutual funds in their Income Tax Return (ITR).

Disclaimer

Investment and securities are subject to market risks. Please read all the related documents carefully before investing. The contents of this article are for informational purposes only, and not to be taken as a recommendation to buy or sell securities, mutual funds, or any other financial products.
Share this article
Copied Link!
Blog
>
Investments
>
Tax Implications of Mutual Funds

Sources

View similar articles in
Investments
Get the Fi app