How is income from Mutual Funds taxed?

Equity oriented mutual funds are those funds which invest minimum 65% of their AUM in equity and equity related instruments. Diversified funds, ELSS, balanced funds - equity oriented and arbitrage funds are equity oriented funds since they invest minimum 65% of their AUM in equities and equity related instruments.

Nov 03, 2016 09:11 IST IIFL Abhimanyu Sofat |

For taxation purposes, mutual funds are classified as - equity oriented funds and non-equity funds. Equity oriented mutual funds are those funds which invest minimum 65% of their AUM in equity and equity related instruments. Diversified funds, ELSS, balanced funds - equity oriented and Arbitrage funds are equity oriented funds since they invest minimum 65% of their AUM in equities and equities related instruments. Whereas, non-equity funds are those funds which do not have to meet the criteria of investing in equity and equity related instruments. Some of the non-equity funds are debt funds, gold funds and balanced funds - debt oriented. And taxation on equity oriented mutual fund and non-equity mutual fund is different. We will first discuss the capital gain tax and then taxation on dividends.
 
Taxation on capital gains from mutual funds

Equity oriented funds
Taxation on equity oriented schemes is alike direct equity investing.  The taxation on gains from equity-oriented funds is categorized into two parts based on the investment horizon – Short-term Capital Gain Tax and Long-term Capital Gain Tax.
  • Short-term Capital Gain Tax: If the investment period of an investor is less than 12 months, then the capital gains are considered as short-term capital gains. The short-term capital gains are taxed at 15.45% (15% plus 3% cess).
  • Long-term Capital Gain Tax: If an investor redeems his investments after 12 months, then the capital gains are regarded as long-term capital gains. Long-term capital gains from equity-oriented schemes are tax-free.
Investment holding period Taxation
Short Term Capital Gain Less than 12 months 15% + 3% Cess = 15.45%
Long Term Capital Gain 12 months or more Nil
Note: 15% surcharge is applicable if the annual income of an investor is above Rs. 1 cr.
 
The below table, the taxation on short-term and long-term capital gains are elaborated using examples. In the below example investor has to pay 15.45% tax on short-term capital gain i.e. Rs. 50,000 of Rs. 7,725 while there is no tax on long-term gains.
Taxation on Equity oriented mutual funds
Short-term capital gain tax Long-term capital gain tax
a) Investment Rs. 5,00,000 Rs. 5,00,000
b) Investment period 11 month 12 months
c) Current Valuation Rs. 5,50,000 Rs. 5,50,000
d) Total Gain Rs. 50,000 Rs. 50,000
e) Applicable Tax rate 15% + 3% Cess = 15.45% Nil
f) Tax Payable Rs. 7,725 Nil
g) Net Gain Rs. 42,475 (f-j) Rs. 50,000
 
Non-equity Funds (debt funds, gold funds, balanced funds - debt oriented)
Taxation on non-equity funds is different from equity-oriented funds. The taxation on gains from these funds is also categorized into two parts based on the investment horizon – Short-term Capital Gain Tax and Long-term Capital Gain Tax.
  • Short-term Capital Gain Tax: If the investment period of an investor is less than 36 months, then the capital gains are considered as short-term capital gains. The short-term capital gains are taxed as per the slab tax of the investor plus and 3% cess.
  • Long-term Capital Gain Tax: If an investor redeems his investments after 36 months, then the capital gains are regarded as long-term capital gains. An investor has to pay 20% of the capital gain with indexation plus 3% cess. Indexation is a method by which the returns are adjusted for inflation during the invested period.
Investment holding period Taxation
Short Term Capital Gain Less than 36 months 30%* + 3% Cess = 30.9%
Long Term Capital Gain 36 months or more 20% with indexation + 3% Cess = 20.60%
*as per the tax slab of the investor, we assumed upper limit.
Note: 15% surcharge is applicable if the annual income of an investor is above Rs. 1 cr.

 
If an investor redeems his debt mutual funds units before 36 months then he has to pay short-term capital gain tax on the capital gains. As shown in the below table, an investor has to pay Rs 46,350 as a tax on Rs. 1.5 lakh as per his income slab (we assumed upper limit). Whereas, the taxation on the long-term capital gains from debt funds is complicated. Let’s take an example to understand long-term capital gain tax on non-equity funds.
 
Let’s assume an investor had invested Rs. 5 lakh in a debt funds on 1st Nov 2013 and the value of the investment was Rs. 6.5 lakh on 1st Nov 2016. The investor redeemed all his investment on 1st Nov 2016. Since the investment period is 36 month the capital gain of Rs. 1.5 lakh is considered as long-term capital gain. The values of the cost inflation index are 939 and 1125 for 2013-14 and 2016-17 respectively. The value of the investment, Rs. 5 lakh, adjusted for inflation is Rs. 5.99 lakh [ Rs.5 lakh*(1,125/939)]. Thus, after indexation the taxable gain is Rs. 50,958 (Rs. 6.5 lakh – Rs. 5.99). The investor will pay 20.6% tax on Rs. 50,958 i.e. Rs. 10,497.
Taxation on non-equity mutual funds
Short-term capital gain tax Long-term capital gain tax
a) Investment Rs. 5,00,000 Rs. 5,00,000
b) Investment period 35 months 36 months
c) Current Valuation Rs. 6,50,000 Rs. 6,50,000
d) Index cost NA Rs. 5,99,042
e) Total Gain Rs. 1,50,000 (c-a) Rs. 1,50,000 (c-a)
f) Taxable Gain Rs. 1,50,000 (c-a) Rs. 50,958 (d-e)
g) Applicable Tax rate 30%* + 3% cess = 30.9% 20% with indexation + 3% Cess = 20.6%
h) Tax Payable Rs. 46,350 Rs. 10,497
i) Net Gain Rs. 1,03,650 (e-h) Rs. 1,39,503 (e-h)
*as per the tax slab of the investor, we assumed upper limit.
Note: 15% surcharge is applicable if the annual income of an investor is above Rs. 1 cr.

 
Taxation on dividend from mutual funds
Dividend in the hand of the investors is not taxable. However, Dividend Distribution Tax of 28.84% is applicable on dividend distributed by the non-equity mutual funds; the DDT is paid by an AMC but indirectly investor bear it.
Dividend
All funds NIL
Dividend Distribution Tax (Payable be the Scheme)
Equity oriented funds NIL
Non-equity Funds 25% +12% surcharge + 3% Cess = 28.84%

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