Mutual fund taxation - How are MF returns taxed?

As soon as we start earning a taxable amount of money, the first thing that comes to mind is the amount of money being paid as taxes. Given the norms on mutual fund taxation, investing in mutual funds is one of the best avenues for you to enjoy the stability and returns you desire to meet your financial goals. However, it can often happen that the gains that you make and the amount of money that is credited to your account differs. This is usually due to taxation. To put it simply, all income that you earn, including the income generated from your mutual fund investments, is subject to taxation. Understanding mutual fund taxation can help you plan your mutual fund investments better.

Mutual fund taxation

The first thing you should know is that, when you invest in mutual funds, you receive returns in two ways – dividends and capital gains. While dividends are the pay-outs emerging from a company’s profit or surplus cash, capital gains are acquired when you sell off the units you hold in the scheme. Both dividends and capital gains are based on the number of mutual fund units you hold. Both of these returns are taxable when you receive them. Now, let us look at the tax on dividends – the dividends you receive from your fund units are added to your taxable income, and then taxed in line with your income tax slab. 

Separately, the capital gains you earn are taxed based on the time frame of your holding, as well as the type of mutual fund you invest in. so, if you invest in equity funds for less than a year, you will be taxed at 15%, and if the investment is more than a year, it will be taxed at 10%, after the initial 1 lakh, which is tax exempt. Equity funds are mutual fund schemes which invest 65% or more of the corpus in equity and equity-related instruments. When it comes to debt funds, which are schemes investing 65% or more of the corpus in debt instruments, then you attract short term capital gains tax, in line with your income tax slab, if you redeem your units within three years. After this duration, your returns are taxed at 20%, irrespective of your tax slab. You also receive an indexation benefit on your redemption, which means that your capital gains can be adjusted to the inflation in the period of investment.   

Hybrid fund and SIP taxation

Now let us move to the taxation of capital gains on hybrid funds. Hybrid funds are mutual fund schemes which have components of both equity and debt in their assets. When you invest in hybrid funds, your capital gains tax depends on the portion of equity and equity-related instruments in the portfolio. If the equity exposure of the scheme is higher than 65%, then your capital gains will be taxed in line with equity funds. If the equity exposure is below the benchmark of 65%, then your investment returns will face taxes in accordance with the norms governing debt funds. Therefore, if you are investing in hybrid funds with the aim of enjoying tax benefits available on equity funds, do check the exposure before you take a decision.

The next question is how much tax you will be charged, if you invest in mutual funds via systematic investment plans or SIPs. When you invest via SIPs, you purchase a certain amount of units every time. If you are holding your units for a period of one-year, from the time of first purchase, your gains will be taxed according to the long term capital gains norms. Therefore, if your capital gains are below 1 lakh rupees, you need not pay any tax. Your lumpsum amount investments will be taxed in line with the details mentioned above.

So, these are the details you need to know about the taxation on mutual funds. Based on these aspects, and your tax requirements, you can choose to invest in equity, debt or hybrid funds. You can also choose which mode you want to invest through – SIP or lumpsum. However, one thing you can be certain about is that mutual fund investments are an excellent way to earn returns while also saving on the tax you pay on these returns.

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