A mutual fund operates under an asset management company that hires a fund management team to look out for the money investors direct into the fund. Collectively, this money forms a pool that the fund management team goes on to invest in diverse securities like equity and debt instruments. Investments of the fund are selected keeping in mind a common objective that is made clear to investors.
Regulations in Place - Although mutual funds are subject to market risks, they are regulated by the Securities and Exchange Board of India (or SEBI). This regulation helps ensure that both investors and mutual fund houses’ are protected without any unfair practices.
Classification – Broadly speaking, mutual funds can be categorised as equity mutual funds and debt mutual funds. In the case of the former, pooled money is primarily directed towards equities, whereas in the case of the latter, pooled money is mainly invested in debt and fixed-income instruments.
To learn more about mutual fund tax benefits, read on.
Among the mutual funds available in the market, equity-linked saving schemes (or ELSS) funds are the only mutual funds that are tax saver mutual funds owing to the tax concessions applicable to them.
The tax benefits linked to equity mutual funds are as follows.
Concessions Under Section 80C of the Income Tax Act (for Equity Mutual Funds)
Equity-linked savings scheme (or ELSS) funds primarily invest in the equity market and purchase their shares via initial public offerings and/ or via the stock market. Investors can claim the amount they invest under this category of mutual funds as per section 80C of the Income Tax Act of 1961. It is important to note that although there is no cap on the extent to which an investor can invest in these mutual funds, there is a limit of ₹1.5 lakhs deduction that can be claimed.
Initially, dividends received from mutual funds were tax-free until March 31st 2020. The company declaring dividends used to pay dividend distribution tax (DDT) before reaching the hands of investors. But from 1st April 2020, the finance act 2020 withdrew DDT, and all investors receiving dividends will be taxed as per their tax slab.
The finance act 2020 also levies TDS on mutual fund companies when distributing dividends post 1st April 2020. The rate of TDS is 10% on the dividend paid in excess of ₹5000 from a company or mutual fund.
Gains drawn from the sale of mutual fund units can be classified as short-term capital gains and long-term capital gains. Taxes applicable on the sale of mutual funds in the case of both forms of capital gains have been explored below.
Taxes Applicable to Short-Term Capital Gains – If you hold equity mutual fund units for a period that falls below a year, the gains drawn from their sale will be levied at a concessional rate of 15 per cent. As per Section 111 A, there isn’t a maximum limit on the amount taxed at this concessional rate.
In the case of debt funds, you attract STCG if you redeem your units within three years. These gains will be taxed as per your tax slab.
Taxes Applicable to Long-Term Capital Gains – If you hold equity mutual fund units for a period that exceeds a year, the gains drawn from their sale will be fully exempt from any capital gains tax if the amount is less than ₹1lakh. If the amount exceeds, then there is a 10% LTCG tax levied, and there is no indexation benefit provided as well.
In debt funds, LTCG tax is applicable if you redeem your units anytime after three years. These are taxed at a flat 20%, and additional cess and surcharge on tax are applicable.
The table below will give a better understanding of how the tax works.
There are no free lunches when it comes to making profits from mutual funds. All gains through mutual funds are taxable. The only exemption is the case of ELSS mutual funds. Investing in ELSS gives you the advantage of claiming a tax benefit in section 80C, but it is limited to only ₹1.5 lakh. When selecting a mutual fund, you should always consider the extent to which it carries risks and whether your investor profile can take on the same with ease or not.
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In the case of equity-linked saving scheme (or ELSS) funds, a tax exemption of up to ₹1.5 lakhs is permitted under Section 80 C of the Income Tax Act of 1961.
Income drawn from mutual funds is taxable post 1st April 2020 as per the finance act 2020. Tax is divided into short-term capital gains (STCG) and long-term capital gains (LTCG) as per the duration of the fund held.
Equity-linked saving schemes are the only mutual funds that qualify for tax exemptions of up to ₹1.5 lakhs under Section 80 C of the Income Tax Act of 1961.
Mutual funds fall under Section 10(23D) of the Income-Tax Act. Only ELSS mutual funds fall under section 80C.
