How mutual fund returns are taxed?
Rajesh has sold his mutual fund units and made a profit of Rs 100,000 and his returns were tax free. On the other hand, Mahesh has also sold his mutual fund units and made a profit of Rs 20,000. However he paid tax on these profits. How is this possible? Do you know how mutual fund returns are taxed? In this article we would discuss about mutual fund returns taxation in India.
Before I jump into actual tax computations for each of the mutual fund category, you need to know 4 things. 1) Equity mutual funds 2) Debt mutual funds 3) Growth mutual funds and 4) Dividend mutual funds.
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In case you are aware of these terms, skip to next section.
Equity mutual funds: For the purpose of taxation, mutual funds are those which invest more than 65% of their portfolio in equity related instruments and balance amount in debt related instruments. It includes balanced mutual funds also. Index funds, large cap mutual funds, diversified mutual funds, Mid-cap funds and balanced mutual funds come under this category. Mutual funds which invest in international markets/equities also fall under this category.
Debt mutual funds: Mutual fund schemes which are other than indicated above are classified under debt mutual funds for taxation purpose. This includes debt mutual funds, liquid mutual funds, fund of funds etc.
Growth mutual funds: Mutual funds schemes where the returns would be re-invested and paid only during redemption are growth mutual funds.
Dividend mutual funds: Mutual fund schemes where they pay regular dividends to investors are dividend mutual funds.
Now, coming to main point, mutual fund returns taxation depends upon these 4 factors, hence it is important for you to know them.
How mutual fund returns are taxed?
We would categorize the mutual fund returns taxation into two. I.e. Growth category and dividend category
I) Growth category
a) Equity mutual funds (Growth)
- Short term capital gains: If you redeem your equity mutual fund units before 365 days (short term), you need to pay 15% tax on the mutual fund returns (Incl. 3% cess would come to 15.45%). E.g. Kishore purchased X equity mutual fund (growth) in Apr-2012 for Rs 5,00,000 and sold in Feb-2013 for Rs 5,10,000. Since the time frame is < 365 days, the returns of Rs 10,000 are taxable @ 15.45% = Rs 1,545
- Long term capital gains: If you redeem your equity mutual fund units after 365 days (long term capital gain), the returns are “tax free”. E.g. Rajesh purchased X equity mutual fund (growth) in Sep-2011 for Rs 5,00,000 and sold in Feb-2013 for Rs 5,50,000 and made a profit of Rs 50,000. Since the time frame is 365+ days which is long term capital gain, the returns are tax free.
b) Debt mutual funds (Growth)
- Short term capital gains: If you redeem your debt mutual fund units before 365 days (short term), the profits are fully taxable. Means you need to add the profits to your taxable income and pay the income tax. E.g. Sreenivas purchased X debt mutual fund (growth) in Apr-2012 for Rs 5,00,000 and sold in Feb-2013 for Rs 5,10,000. Since the time frame is < 365 days, the returns of Rs 10,000 added to Sreenivas taxable income and tax needs to be paid based on the tax slab.
- Long term capital gains: If you redeem your debt mutual fund units after 365 days (long term capital gain), the tax would be lowest of the a) 10% tax without indexation benefit b) 20% tax after indexation benefit
E.g. Govt. of India provides the indexation data every year. For year 2010-11: 711 and 2011-12: 782 and 2012-13: 852. Mahesh purchased X debt mutual fund (growth) in Sep-2011 for Rs 5,00,000 and sold in Feb-2013 for Rs 600,000.
Computation based on 10% tax without indexation benefit
- Rs 600,000 – Rs 500,000 = Rs 100,000
- Tax = Rs 100,000 x 10% = Rs 10,000
Computation based on 20% tax after indexation benefit:
- Indexed value is 500,000 x 852/711 = Rs 599,156.
- Taxable amt would be Rs 600,000 – Rs 599,156 = 844
- 20% tax on taxable amount is Rs 844 x 20% = Rs 17.
Lowest of above two computations is Rs 17, hence your tax liability would be only Rs 17.
II) How to calculate tax on mutual funds with dividend option?
a) Equity mutual funds: There is no tax on mutual funds dividend you receive from equity mutual funds. It is tax free in your hands.
b) Debt mutual funds: You need not pay any tax on mutual funds dividend you receive from debt mutual fund. But the mutual fund company is liable to pay Dividend Distribution Tax to the government before paying the dividend to you.
Well, then how much is Dividend Distribution tax in debt mutual funds (DDT)
For Liquid funds and money market funds, the DDT is 25%. There is another 5% surcharge on it along with 3% cess. So, the effective rate of tax will be 27.0375 %( 25% tax+ 5% surcharge+3% cess).
In other debt funds, the DDT rate is lower. It is 12.5 %. There is another 5% surcharge on it along with the 3% cess. So, the effective rate of tax will be 13.5188%.
Will they deduct tax on mutual funds income?
No, the fund house will not deduct the tax from your gain. You have to calculate and pay tax on mutual fund income and include in your income tax return. Regarding NRIs, tax on mutual funds will be deducted as per the applicable rates before redeeming the amount.
Here is the quick snapshot of mutual funds taxation in a table.
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How mutual fund returns are taxed
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