Mutual funds tax structure

Capital Gains Taxes on Mutual funds

by Shruti Agarwal on Basic Finance, ETFs & Mutual Funds

As an asset-class mutual funds have developed as a lucrative investment option. More and more investors are lured to invest in mutual fund units. Mutual funds provide the benefit of a diversified portfolio comprising of both equity and debt. Talking about taxation, the mutual fund also provides an exemption to dividend income received on mutual fund units.

Hence, discussing about investment options in mutual funds will be useless without acknowledging the tax-related implications on the same.

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This blog discusses about the taxation structure of mutual funds in India subject to the provisions of the Income Tax Act, 1961 (Act, 1961)

Also ReadBasic Facts You Must Know About Mutual Fund Schemes

Introduction

Mutual funds are included in the definition of capital assets under the provisions of the Act, 1961. Thus, the provisions of taxation applicable to the capital assets are applicable to mutual funds as well.

Also ReadA Brisk Understanding On How To Invest In Mutual Fund Scheme

Any gains arising from the transfer of a capital asset are taxable under the head Capital Gains (CG).

These capital gains are further classified under Long Term Capital Gains (LTCG) or Short Term Capital Gains (STCG) depending upon the period of holding of the capital asset.

Long Term Capital Asset (LTCA)

Any capital assets held for a period of more than 36 months immediately preceding the date of transfer of that asset will be considered as a LTCA.

However, certain assets which includes equity oriented mutual funds, the holding period of such assets shall be considered 12 months.

Also Read: Invests wisely, Invest in Equity Linked Saving Scheme (ELSS)

Short Term Capital Asset (STCA)

Any capital assets held for a period of less than or equal to 36 months immediately preceding the date of transfer of that asset will be considered as a STCA.

However, certain assets which includes equity oriented mutual funds, the holding period of such assets shall be considered 12 months.

Factors affecting the tax status of mutual fund.

Residential StatusTypes of Mutual FundHolding period
Whether the mutual fund holder is a Resident or a Non- Resident.Whether the mutual funds are equity oriented or non-equity oriented mutual funds.

Whether the mutual funds are long term capital asset or short term capital asset as discussed above.

Any capital gains received from the redemption of the mutual units will be taxable under the provisions of the Act, 1961 as follows:

Status: Resident Indian

Type of schemeSTCG rateLTCG rate
Equity oriented mutual funds15%NIL
Non-equity oriented mutual fundsIncome tax slab applicable20% (Indexation benefit)

Status: Non-Resident Indian

Type of schemeSTCG rateLTCG rate
Equity oriented mutual funds15%NIL
Non-equity oriented mutual fundsIncome tax slab applicable

Listed – 20% (Indexation benefit)

Unlisted – 10% (No indexation benefit)

Apart from the above tax structure, dividends received by the unit holders both in case of equity and non-equity mutual funds is non-taxable.

However, in case non-equity / debt funds the mutual fund company is required to pay a Dividend Distribution Tax (DDT) @28.84% on the distributable dividend.

Also ReadWhy should you own debt funds?

Now, let us understand the above concept with the help of few illustrations mentioned below:

Illustration 1:

Treatment of equity-oriented mutual fund

Mr. Mayank is a salaried employee. On 01.01.2013, he purchased 100 units of a XYZ mutual fund @Rs. 100 per unit. The units purchased were equity oriented mutual fund.

These units were sold through Bombay Stock Exchange (BSE) on 01.04.2015 @ Rs. 150 per unit. (Securities Transaction Tax (STT) was paid at the time of sale).

What will be the nature of capital gain in this case?

In the above case, mutual fund units were purchased in Jan, 2013 and sold in April 2016, which means that the units have been sold after holding them for more than 12 months.

Hence, the gain will be long-term in nature (as mentioned above, that the holding period of equity-oriented mutual funds having a holding period of more than 12 months are considered long-term unlike the period of 36 months for others.)

As mentioned above, the units are equity oriented and are sold after holding them for a period of more than 12 months.

Further, mutual fund units were sold through BSE and subject to STT as well, hence, the provisions of Section 10(38) of the income Tax Act, 1961 shall become applicable and no taxes will be charged on the gains.

Note: Section 10(38) of the Income Tax Act, 1961 grants exemption to long-term equity-oriented mutual funds which are subject to the Securities Transaction Tax(STT). As in the above case, all the conditions are adhered, Section 10(38) becomes applicable.

Illustration 2:

Treatment of debt-oriented mutual fund

By taking Illustration 1 under consideration, if the mutual funds are debt-oriented in nature, then Section 10(38) does not become applicable and in that case, Mr. Mayank cannot claim any exemption.

Section 10(38) required fund, as mentioned above, is required either to be equity or equity-oriented in nature and these are debt-oriented, hence no exemption.

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