Paying taxes is a constant part of adulting, be it on a meal from your favourite restaurant or on the gains you make through your equity mutual fund investments. The applicable tax on equity mutual fund gains can vary based on how long you stay invested and the type of equity scheme you’ve invested in.
So, let’s dive into the tax on equity mutual funds so you can plan your investments better.
Usually, people invest in equity mutual funds for the long term. Ideally, you should stay invested in these schemes for five years or more to take advantage of compounding your gains and the lesser of the two applicable capital gains taxes - the long-term capital gains tax.
But for whatever reason, if you need to withdraw these funds within a year, any gains you make will be treated as short-term gains. That means you’ll have to pay 15% as short-term capital gains tax, along with the applicable cess and surcharge.
On the other hand, funds withdrawn from equity mutual funds after a year are treated as long-term capital gains. Here, you pay 10% plus cess and surcharge. You also don’t get the benefit of indexation (gains adjusted for inflation) on this tax burden, However, long-term capital gains below ₹1 lakh are exempt from equity mutual fund taxation.
Let’s take an example to understand this better. Say, you’ve invested ₹1 lakh in an equity mutual fund scheme and made an astounding 25% gain per year over the last five years. That means the value of your investment stands at ₹2.25 lakh. Now, if you need to withdraw ₹1,10,000 at this point for an emergency, you will pay long-term capital gains tax only on ₹10,000 since your gains up to ₹1 lakh are exempt.
Before we move on with understanding more about equity mutual fund taxation, two points to take away here are:
There’s another type of tax you should be aware of if you're investing in equity mutual funds. The Dividend Distribution Tax or DDT is applicable only to those equity mutual funds that pay dividends to investors. And they do this by investing in the stocks of companies that pay dividends, or in other words, companies that share their profits with shareholders.
Until 2020, companies paid DDT to the government. But the Union Budget that year brought about a change in these rules that placed the burden of this tax in the hands of individual investors. Earlier, DDT was exempt until up to ₹10 lakh for companies.
Now, dividends paid out after April 1, 2020, will be added to the individual investor’s income and will be taxed as per their applicable income tax slab. As per these changes, Tax Deducted at Source (TDS) becomes applicable on such income.
So, your dividend income from equity mutual funds is levied with TDS at the rate of 10% plus cess and surcharges. This is subject to an exemption on dividends earned up to ₹5000 for each financial year.
If you’ve found yourself frantically looking for ways to reduce your tax burden at the end of the financial year, you’ve probably heard of Equity-Linked Savings Schemes (ELSS). If you haven't, here's a quick explainer on these highly tax-efficient mutual fund schemes.
Under Section 80C of the Income Tax Act, investments in ELSS can be deducted from your income tax liability up to ₹1.5 lakh per year. This is the only equity-oriented tax option under section 80C deductions and comes with the lowest lock-in period of three years. However, it is important to remember that due to the lock-in period, your gains from this investment will be subject to the long-term capital gains tax.
While equity funds may appear daunting, after reading about them and understanding how they work, you should be able to get the hang of it. It is important to remember a few pointers, such as which equity funds work for you and taxation on equity funds. If you’ve got this bit of information down, it should be smooth sailing for you. While it may be arduous to invest in mutual funds, the Fi App makes it more understandable and easier to navigate, especially for novice investors.
Equity mutual funds i.e. those that have a minimum of 65% of assets under management invested in equity are subject to tax on equity mutual funds. If these investments are held for less than a year, the gains are subject to short-term capital gains tax at the rate of 15% plus cess and surcharge. For investments held for more than a year, long-term capital gains tax of 10% plus cess and surcharge is applicable.
Only the gains from equity mutual funds are subject to taxation. According to the Union Budget of 2020, the Dividend Distribution Tax has been abolished for companies. However, this tax burden has been placed on individual investors, making dividend income taxable as per the applicable income tax slabs.
If the units of the equity mutual fund are withdrawn within 12 months of investment, then they are taxed at 15%, with the addition of cess and surcharge. However, if withdrawal is made after 12 months, it becomes a long-term capital gain and hence is taxed at 10%. If the gains accrued are less than ₹1 lakh in value, they are exempt from taxation on equity mutual funds.
As per section 80C of the Income Tax, 1961, investments which are made in Equity-Linked Saving Schemes (ELSS) can be deducted from your taxable income. However, the deduction is capped at ₹1.5 lakh.
Yes, gains accrued on equity mutual funds that are withdrawn within 12 months of investing i.e. short-term gains, are liable to 15% tax plus cess and surcharge. On the other hand, equity mutual fund investments that are withdrawn after 12 months are subject to long-term capital gains tax of 10% plus cess and surcharge.
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