Mutual funds are financial vehicles that combine the capital of several investors to build a diverse portfolio of stocks, bonds, and other assets. Professionally qualified fund managers manage mutual funds. Buying mutual funds is the most common strategy used by people to build their wealth and reach their financial objectives. However, it’s critical to understand the tax implications of investing in mutual funds.
Several regulations controlling different kinds of payouts and profits may complicate mutual fund taxes. We’ll explore taxation on mutual funds in this article, including dividends, long-term capital gains (LTCG), and short-term capital gains (STCG).
What is Tax on Mutual Funds?
This term describes the charge levied by the state on profits made from investing in mutual funds. When investors redeem their mutual fund units or get dividends on their investments, these taxes are due.
A lot of people do investment planning only based on long and short-term returns and ignore the tax implications. However, they need to account for the investment duration, type of mutual funds and scheme type chosen (growth or dividend), to understand the tax on mutual funds withdrawals and make an informed decision.
How Capital Gains & Dividends Work in Mutual Funds
Capital gains, in general, are the gains realized when an investor sells their mutual fund units for more than the cost. These profits fall into one of two categories: short-term or long term capital gain tax on mutual funds, depending on the time period.
Profit made on mutual fund units held for one year or less is known as short-term capital gains. While profit made on units kept for more than a year is termed as long-term capital gains.
On the other hand, the dividend income on a mutual fund arises when the fund distributes the gains to its shareholders via income payout.
Investors need to pay taxes on this income.
Factors That Determine Tax on Mutual Funds
The holding time, the kind of profits or dividends, the investor’s tax bracket, and the mutual fund scheme type (equity or debt-oriented) are some factors that affect taxability on mutual funds in India.
Scheme Types
Depending on the kind of mutual fund scheme, investments have different tax treatment. Mutual funds that are geared toward stocks or equity-related products, as opposed to those that are primarily focused on debt securities, are taxed differently.
Dividend and DDT
Investors in mutual funds may get dividends from their gains. The tax consequences associated with these payouts vary based on whether equity- or debt-oriented mutual funds distribute them and if Dividend Distribution Tax (DDT) is applicable.
Tax Bracket
The tax rate on short-term capital gains is as per the slab rate of investors. As a result, those with higher tax rates may have to pay more in taxes than people in lower tax brackets.
Holding Period
The amount of capital gains tax that an investor must pay depends in large part on how long they own their mutual fund units. Investments are usually divided into two categories: short-term and long-term, with varying tax rates applied to each.
Types of Tax on Mutual Fund Capital Gains
Here you need to understand what short-term capital gains (STCG) and long-term capital gains (LTCG) mean.
Tax on Short-Term Capital Gains (STCG)
Investors’ applicable income tax slab rate is applied to short-term capital gains from mutual funds. This can vary for individual investors based on their overall taxable income, from 5% to 30%.
Long-Term Capital Gains (LTCG) Tax
If long-term capital gains from equity-oriented mutual funds surpass Rs. 1 lakh in a financial year, they are subject to a flat 10% tax. Long-term capital gains from debt-oriented mutual funds, on the other hand, are subject to 20% taxation.
Types of Tax on Mutual Fund Dividends
The dividends received from mutual funds are counted as income of the investor as per the Finance Act, 2020.
Dividend Distribution Tax (DDT)
Dividends issued by mutual funds are subject to the Dividend Distribution Tax (DDT), before getting paid to investors. The present tax regulations impose a DDT rate of 10% (plus applicable surcharge and cess) on equity-oriented mutual funds and a 25% DDT rate (plus applicable surcharge and cess) on debt-oriented mutual funds.
Dividend Tax in the Hands of Investors
Dividends from mutual funds were tax-free in the hands of investors prior to April 1, 2020. However, post the new norms, dividends have been taxed at the rates of the corresponding income tax bracket of investors.
How to Calculate Your Tax on Mutual Funds?
Different mutual funds attract different kinds of taxation. In order to calculate tax on mutual funds, one must first identify the kind of profits (long-term or short-term) or dividends received, then apply the appropriate tax rates.
To determine the tax amount, separate the capital gains, and then determine whether the gain is LTCG or STCG. Finally, compute the total tax you owe on mutual funds in India by applying the tax percentage on each gain. To precisely calculate their tax obligations, investors can utilize income tax calculators as provided by Dhan.
Conclusion
Investors should be aware of the tax on mutual funds withdrawals in order to maximize their profits and make wise investment decisions. Based on this information, you can make an informed decision about which funds to invest in and for what duration. Investors can reduce their tax responsibilities and manage their investments more efficiently by being aware of the taxation on this asset class.
FAQs
How much tax do you pay on a mutual fund?
An investment holding of less than a year attracts STCG at an investor’s applicable income tax slab rate. Holding of more than a year attracts a 10% LTCG tax.
How do I avoid tax on mutual funds?
By selecting tax-efficient investment methods, such as investing in tax-saving mutual funds (ELSS), selecting the growth option over the dividend option, and carefully timing redemptions, you can save capital gains tax.
Which mutual fund is tax-free?
Popular choices for tax-saving investments include equity-linked savings schemes (ELSS), which are tax-saving mutual funds and provide tax benefits under Section 80C of the Income Tax Act.
Is mutual fund SIP taxable?
Mutual fund Systematic Investment Plans (SIPs) are not subject to separate taxes. However, any profits or dividends received from SIP investments are taxable in accordance with the laws.
📌 You can also read:
- Best ELSS Funds to Invest in 2024
- ETF Vs Mutual Fund: Which Is Better?
- Different Types of Mutual Fund Schemes
- 10 Best SIPs for 3 Years Investment
Happy Investing 💰
Disclaimer: This blog is not to be construed as investment advice. Trading and investing in the securities market carries risk. Please do your own due diligence or consult a trained financial professional before investing.
