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Mutual Funds Taxation - How are Mutual Fund taxed in India

Usually, investors in mutual funds make profits on the capital invested through capital appreciation and dividend receipts. The fund house declares dividends in the event of equity funds as and when the fund makes earnings.

Similarly, a debt fund's underlying assets provide investors with regular interest at a set rate. This way, as you move forward in your investment horizon, the value of your mutual fund continues to grow. This brings capital gains that tend to be taxable to investors.

Capital gains are the difference between your investment's sell value and the original purchase price.

A differential tax rate is implemented across fund types in the context of mutual funds. This tax rate relies on the type and holding period of mutual funds. Holding duration relates to the tenure for which an investor remains invested in a mutual fund scheme.

Holding duration can be both short-term and long-term. A holding period of up to 1 year is considered to be short-term in the case of equity funds and a holding period of more than 1 year is referred to as long-term. For debt funds, a holding period of up to 36 months (3 years) is referred to as short-term and is considered to be longer-term for more than 36 months.

How are Mutual Funds Taxed on Capital Gains?

The short-term capital gains are known as short-term capital gains (STCG). Long-term capital gains (LTCG) are regarded as long-term capital gains.

Depending on their holding periods, equity and debt funds are taxed differently. Short-term capital gains (STCG) on equity fund unit redemption are taxable at a rate of 15%. Long-term capital gains (LTCG) are tax-free on equity funds up to Rs 1 lakh. However, LTCG on the redemption of the equity fund exceeding Rs 1 lakh is taxable at a rate of 10 percent without indexation advantage.

The short-term capital gains on debt fund units are part of the investor's full revenue and are taxable on the basis of his income slab. However, with the advantage of indexation, long-term capital gains on debt fund redemption are taxable at a rate of 20 percent. In the case of indexing, the cost of acquiring the units can be adjusted based on the cost inflation index (CII) of the year of sale and year of purchase.

Indexed cost of acquisition (ICoA) is computed as follows:

ICoA = (Purchase Price * CII of year of sale)/(CII of the year of purchase)

Indexation's primary aim is to inflate the procurement price of the asset in order to decrease the resulting capital gains. The investor can thus reduce his overall tax liability.

How Mutual Fund Dividend is Taxed

There is no tax liability on investors when it comes to the dividend received from equity mutual funds. However, dividends reach in the hands of investors after a deduction of Dividend Distribution Tax (DDT) at 11.648% (including surcharge and cess), thereby reducing the overall in-hand return.

Debt mutual funds dividends are tax-free in the investor's hands, but debt mutual funds dividend payouts are subject to a dividend distribution tax of 29.12 percent (including cessation and surcharge). This efficiently lowers investors ' in-hand returns.

How to Manage Mutual Fund Taxation

Taxing on mutual fund capital gains should not prevent you from exploring its potential for return. In fact, through mutual fund investments, you can generate a lot of wealth and achieve your goals.

Follow these easy tips to handle your tax on mutual funds instead of getting stressed

  • Make sure you fully comprehend the product before investing in any mutual fund scheme.
  • Throughout the investment horizon, you can remain invested in the product without making unplanned exits that attract tax liability.
  • Analyzing the funds for qualitative and quantitative reasons helps prevent selecting inappropriate funds. Consult a professional financial advisor in case of any difficulties.
  • Refrain from frequent buying and redeeming units from the mutual fund.
  • Consider the tax implications if you plan to initiate a systematic transition from debt to equity fund or vice versa.
  • Every redemption shall be regarded as withdrawal and shall be taxable according to the holding period.
  • While investing in equity funds, in order to realize the complete potential, have a long-term horizon of more than 5 years.

Conclusion

Remember that the maximum exemption limit in LTCG for equity funds is Rs 1 lakh per year. You can think of positioning your investment portfolio in such a way as to make the greatest possible use of this regulation.

Your entire investment in mutual funds should be about your economic objectives. It is possible to redeem those funds that do not function according to your objectives quickly. Diversify that money into funds that have continuously been doing well.


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