Everyone wants to minimize their tax. It is possible to save taxes by investing in the right channels that offer tax advantages and deductions. Even though the new tax regime of 2020 does not offer any tax exemptions for investments, you can still avail of tax deductions on smart investments by filing your taxes through the old regime. One effective investment that can generate high returns while allowing you to save taxes is mutual funds. However, understanding mutual fund taxes can be slightly challenging. Your mutual fund taxes typically depend on the types of funds you invest in, the tenure of your investment, and your current income tax slab.
Here is a complete taxation guide on mutual funds:
How do mutual funds generate returns?
Mutual funds allow you to earn returns through dividends and capital gains. Dividends are paid from the company profits, and capital gains arise when you sell a security for a higher price than your purchase price. Both dividends and capital gains are taxable for you.
Taxation for dividends
Initially, dividends up to Rs. 10 lakhs were tax-free for investors, and the companies were required to pay dividend distribution tax (DDT). Any dividends above Rs 10 lakhs per financial year attracted a 10% tax.
Taxation of capital gains
The taxation of capital gains depends on the type of mutual fund and the holding period. Capital gains realized for different durations and types of funds are:
- Equity funds: If you invest in equity mutual funds and hold the investment for less than 12 months, you generate short-term capital gains. Alternatively, if you hold your mutual funds for longer than 12 months, you generate long-term capital gains.
- Debt funds: If you invest in debt funds and sell them before 36 months, short-term capital gains arise. However, if you hold your debt funds for longer than 36 months, there are long-term capital gains.
- Hybrid equity-oriented funds: If you invest in hybrid equity-oriented funds and hold your investment for less than 12 months, short-term capital gains arise. Alternatively, if you keep your investments for 12 months or longer, you generate long-term capital gains.
- Hybrid debt-oriented funds: If you invest in hybrid debt funds for less than 36 months, you get short-term capital gains, and if you hold it for longer than 36 months, you generate long-term capital gains.
The short-term and long-term capital gains from mutual funds are taxed differently. Short-term equity capital gains are taxed at 15% flat, irrespective of your income tax bracket. In contrast, long-term equity capital gains up to Rs. 1 lakh annually are free from taxes. Long-term equity capital gains from mutual funds above this limit are taxed at 10%. There is no benefit of indexation.
In the case of debt mutual funds, short-term gains are added to your income and taxed at ordinary income tax rates. Long-term capital gains from debt mutual funds are taxed at 20% after indexation. You also have to pay applicable cess and surcharge on the tax.
Securities Transaction Tax (STT)
Apart from the capital gains tax, mutual funds also carry an STT of 0.001% levied by the Ministry of Finance. STT is applicable on the purchase or sale of equity mutual funds. There is no STT on debt mutual funds.
Apart from paying taxes, you get tax deductions up to Rs. 1.5 lakh under Section 80C for specific mutual fund investments. Further, the longer you hold your mutual funds, the more tax efficient they become.
Use the Tata Capital Moneyfy app to invest, monitor, and manage your mutual fund investments.