Anyone investing invests with the aim of getting capital appreciation. And capital gains earned through a mutual fund is taxable. While capital gains are taxable directly to the investor and tax on dividends of mutual fund called Dividend Distribution Tax (DDT) is paid by the AMCs (Asset Management Companies) on behalf of the investor.
Based on investment tenure, there are two types of capital gains tax – Short-Term Capital Gains Tax (STCG) and Long-Term Capital Gains Tax (LTCG).
Short-Term Capital Gains Tax (STCG) – In Equities, short term investment is if the holding period is less than 12 months. Whereas, debt funds are termed as short term if the holding period is less than 36 months. In short, any investment with a holding period of fewer than 3 years fewer as short-term.
Long-Term Capital Gains Tax (LTCG) – In the case of equities holding period more than 12 months the as long-term. Whereas, in debt funds holding period of more than 36 months is termed as long-term.
Now let’s discuss what is capital gain – Capital gain refers to the difference between the amount at which an investor purchased a unit and the amount at which the person redeemed the unit. For instance, assume that Mr. A invested an amount of Rs 10, 000 in a mutual fund scheme in the year 2015 and redeemed the units at Rs. 15, 000 in 2018 then the capital gain is of Rs 5000.
Equity funds and debt funds are taxed differently according to their holding periods –
- The short-term capital gains (STCG) on the redemption of equity fund units are taxable at the rate of 15%. The long-term capital gains (LTCG) on equity fund up to Rs 1 lakh is tax-free. However, LTCG on equity fund redemption, Rs 1 lakh is taxable at the rate of 10% without the benefit of indexation.
- In case of debt fund, 36 months investment is considered as a short term while more than 36 months is considered long term so for STCG the tax is deducted based on income slab of a person and in case of LTCG capital gain is taxable at the rate of 20% after indexation.
Indexation – It means adjustment of capital gains to CII (Cost Inflation Index), this is helpful in reducing taxes. And is applicable only on LTCG earned on non-equity oriented mutual funds.
Taxation on Mutual Funds –
- ELSS (Equity Linked Saving Schemes) or Tax-Saving Equity Fund – These funds come with a lock-in period of 3 years and is the most efficient tax-saving instrument under section 80 C. At the time of redemption, if your investment amount is more than 1L then LTCG will be applicable at 10% without indexation. If the amount is less than or equal to 1L, then you are not liable for any tax.
- Non-Tax Saving Equity Funds – Long-term capital gains (LTCG) on non-tax saving equity funds up to Rs 1 lakh is free of taxation. LTCG above Rs 1 lakh is taxable at the rate of 10% without the benefit of indexation. Furthermore, there is a 15% tax (surcharge and cess as applicable) on short-term gains from equity funds (Where STT is applicable) upon redemption of units before the completion of 12 months.
- Debt Funds – LTCG on debt funds are taxable at the rate of 20% after indexation.
The longer you hold onto your mutual fund units, the more tax-efficient they become. The tax on long-term gains is comparatively lower than that of the tax on short-term gains.
In case you need guidance on tax-saving funds you can contact Ashutosh Securities Private Limited and save tax.
(Mutual Fund investments are subject to market risk Illustrations are for example only, there is no guarantee of returns. Past performance is not an indicator/guarantee to future returns).