Tax provisions for investment in mutual funds

Debt MFs have a differential tax treatment compared to equity. While dividends are tax free for equity schemes, they are taxed in debt funds through dividend distribution tax. Similarly, there is no tax on long term capital gains in equity while same is taxed in debt MFs

November 09, 2012 11:01 IST | India Infoline News Service
Our investment decisions are guided not only by the benefits which a particular financial product offers, but also by the current tax provisions that the instrument is subject to. Like any other financial product, there are tax implications of investing in mutual fund schemes too. Various types of mutual fund schemes are subject to different tax provisions. The tenure of investment is also an important factor when deciding upon one’s tax liability. Therefore, we must have a proper understanding of the relevant tax provisions, to help us plan our investments in a better manner.

There are various types of MF schemes available in the market. You can invest in any MF scheme depending upon your risk profile and financial profile. However, we often get confused about tax liability on MF return—which we receive.

In this article, we will try to understand the tax liability of MF return for financial year 2013-14.
Tax liability in case of investment in MFs may occur in the following circumstances:
  • Income / dividend distribution by a scheme
  • Gain/loss from the redemption of MF units
First, let’s discuss about the tax implication on dividend income received by MF unitholder.

Tax on dividend paying equity MF 
The dividend received in hands of unitholder for an equity MF is completely tax-free. The dividend is also tax-free to the mutual fund house. This means, the fund house is also not liable to pay any tax on the dividend received. Thus for equity MF, dividend is tax-free for both—unitholder and fund house.

Long term capital gain tax 
Capital gain tax refers to the profit which we make on our mutual fund investments when we redeem or sell them. Let’s assume: Nirav brought units of equity mutual funds for Rs. 1 lakh a year ago. He redeems (sells) these units after 12 months for Rs. 1.25 lakh. Here, Nirav makes a capital gain (profit) of Rs. 25,000. Thus, if we hold units for more than 12 months and gain money from their redemption, we have to pay long term capital gain tax (LTCG). LTCG tax is tax-free for equity funds. However, securities transaction tax will be deducted on equity funds at the time of redemption / switch to the other schemes or sale of units.

Equity oriented MF schemes for FY13-14 
Tax Tax rate for individuals, HUF
Long term capital gain tax Exempt or nil
Short term capital gain tax 15% (units held for 12 months or less)
Dividend income Exempt or nil
Short term capital gain tax
If the units are held for less than 12 months, they would be treated as short-term capital assets and gain arising from redemption/sale of such units is treated as short term capital gain.

In the same example: If Nirav redeems his MF units within six months (instead of a year) and gains Rs. 25,000, he has made short term capital gain (STCG) and has to pay STCG tax. STCG tax on MF schemes is 15% for FY13-14. Therefore, Nirav has to pay Rs. 3,750 for FY13-14 (Rs. 25,000 x 15% = Rs 3,750).

Keep in mind, LTCG tax on redemption of equity oriented MF schemes is tax free. The investor has to hold his investment for long term which is more than a year. For STCG tax on equity oriented MF schemes is taxable at 15%. For individuals and HUF (Hindu Undivided Family), STCG tax on equity oriented MF schemes is 15% for FY13-14.

Long term capital gains on debt MFs
Debt mutual funds have a differential tax treatment compared to equity. While dividends are tax free in equity MFs they are taxed in debt funds through dividend distribution tax. Let's analyze how investment in debt mutual funds will be taxed for FY13-14.
For debt MFs, there is no exemption available for long term capital gains and the following tax rate would apply:
  • 10% without indexation
  • 20% with indexation
Thus, for all types of debt MFs, the unitholder is liable to pay LTCG tax with indexation or without indexation whichever is lower. For individuals / HUFs, it is 10% without indexation and 20% with indexation for FY13-14.

Capital gain tax & DDT for debt MFs for FY14  
Tax Tax rate for individuals & HUFs
Long term capital gain tax 10% without indexation or 20% with Indexation whichever is lower
Short term capital gain tax 30% (assuming the investor falls in the highest tax bracket)
Dividend income Exempt or nil
DDT 25% (applicable from 1 June 2013)
Short term capital gains on debt MFs for FY14
Short term capital gain tax on debt mutual funds is 30% for FY14 assuming that the investor falls into the highest tax bracket.

For example, if an individual comes under 30% income-tax slab, STCG tax would be 30%.

DDT on debt MF for FY14
The dividend income received by a unitholder on his debt MF schemes is tax free for individual and HUF. But, the mutual fund company has to pay a dividend distribution tax (DDT) before distributing this income to its investors. The rates of DDT are as follows: For an individual / HUF, DDT is 25% from June 2013. However, investors may note that such dividends received by them would not be taxed in their hands.

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