January to March is that period in the year when most people plan their taxes. People know the basic taxation principles like allocation to ELSS schemes is tax free post 3-year taxation period. Or debt schemes provide indexation benefits if invested for 3-year and above. But most people are unaware of several other taxation rules. In this article, we provide investors with 10 key mutual fund taxation rules.
The 65% equity rule
If 65% or more of the corpus of a mutual fund scheme is invested in equities – stocks, derivatives and other equity linked instruments, it is treated as equity scheme for the purpose of taxation. Therefore, Arbitrage Funds, Aggressive Hybrid Funds & Equity Savings Funds are also treated like equity funds from tax perspective.
Equity funds taxation: Short term capital gains
If you redeem your equity fund investments within a year, returns or gains are treated as short-term capital gains (STCG) and taxed at 15%.
Equity funds taxation: Long term capital gains
On the other hand, gains on equity mutual funds held for more than a year are treated as long-term capital gains (LTCG). And you have to pay a 10% tax on gains exceeding Rs 1 lakh a year on equity investments (this came into effect from Union Budget 2018).
Also, if you had invested in equity mutual funds or shares before 31 January 2018, gains till that date will be considered as grandfathered and will be exempt from tax. This is because equity taxation norms were announced on February 1, in the Union Budget 2018, with rules applicable on prospective basis.
Dividends from equity funds: How they are taxed
Dividends from equity mutual funds are tax-free in the hands of investors. But they are paid after deducting a dividend distribution tax (DDT) of 11.648% (including surcharge and cess), which reduces the in-hand return for investors.
Taxation of international funds, fund of funds
For income tax purposes, international funds (which invest in stocks listed abroad) and fund of funds (a mutual fund scheme that invest in different mutual funds) are considered as debt funds. Tax rules that apply to debt funds are also applied to gains or returns from international funds and fund of funds.
Taxation of debt funds: Short term capital gains
In case of debt funds or non-equity funds, if you sell your investments in less than three years of holding, gains or returns are treated as short-term capital gains for taxation purpose. Short-term capital gains are added to your income and taxed according to your applicable income tax slab.
Taxation of debt funds: Long term capital gains
If the holding period of debt fund investments is more than three years, returns are considered as long-term capital gains for taxation purpose and taxed at 20% with indexation benefit. Indexation means adjustment of gains after taking inflation into consideration. So, if you have invested in a debt fund for over three years, you will be paying taxes only on the returns over and above the inflation-adjusted initial investment.
Dividends from debt funds: How they are taxed
Dividends from debt mutual funds are tax-free in the hands of the investor but dividend pay-outs from debt mutual funds are subjected to a dividend distribution tax of 29.12% (including cess and surcharge). This effectively reduces the in-hand return for investors.
Taxation of gold ETFs
Gold Equity Traded Funds (ETFs) are taxed similar to debt funds i.e. short term capital gains for investment period less than three years and long term capital gains for investments more than three years. Securities Transaction Tax (STT) -levied on the value of taxable securities transactions which is typically 0.1% on the turnover, is not applicable to Gold ETFs.