Taxation in Mutual Funds

ET IN THE CLASSROOM

Investors  must  understand  the tax implications of financial products while investing. This helps them optimise their post-tax returns. A look at how mutual funds are taxed.

How Are Investments in Mutual Funds Taxed?

There is no tax while investing in or holding a mutual fund, unlike a fixed deposit. The tax incidence arises when you sell, switch from one scheme to another, or redeem the investment. The gains earned in mutual fund schemes are subject to tax based on the type of scheme.

How Are Equity Mutual Funds Taxed?

Any  mutual  fund scheme that is equity-oriented and has more than 65% of its portfolio invested in domestic equities qualifies for long-term capital gains (LTCG) tax of 12.5% if held for more than one year. If sold within one year, the investor will pay short-term capital gains (STCG) tax of 20%. In addition, long-term capital gains of up to 1.25 lakh in a financial year are completely exempt from tax.

What About Debt Schemes?

In debt funds, gains are taxed in line with the investor’s income-tax slab, irrespective of the period of holding. A debt mutual fund is generally defined as one that invests less than 35% of its portfolio in equity shares of domestic companies.

How Are Hybrid Funds Taxed?

Hybrid funds combine multiple asset classes such as equity, debt and gold. Often, fund houses structure these schemes in a manner that allows investors to benefit from equity taxation even with relatively lower equity exposure.

The aggressive hybrid category maintains 65–75% in equity, with the balance in fixed income, and qualifies for equity taxation. In the balanced advantage and equity savings categories, the fund manager maintains minimum equity plus arbitrage component above 65% to qualify for equity taxation.

Multi-asset funds, which are required to have a minimum of 10% each in equity, debt and gold, are categorised further. Funds that have 65% or more equity, including arbitrage, are taxed as equity. Those with equity allocation between 35% and 65% must be held for more than three years to qualify for long-term capital gains tax of 12.5%. Income plus arbitrage funds, which combine debt and arbitrage, are taxed at 12.5% if held for more than 24 months.  

Invesco Mutual Fund

An investor education and awareness initiative

For Know Your Customer (KYC) guidelines along with documentary requirements and procedures for change of address, phone number, bank details, etc., please visit the Education and Guidance section on www.invescomutualfund.com. Investors should deal only with registered Mutual Funds, details of which can be verified on the SEBI website. For any grievance or complaint, please call 1800-209-0007 or write to mfservices@invesco.com. Complaints can also be registered on the SEBI SCORES portal.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

How Are Products with Precious Metals as Underlying and Fund-of-Funds (FOFs) Taxed?

An equity fund-of-fund that invests at least 90% of its total proceeds in equity exchange-traded funds qualifies for long-term capital gains tax of 12.5% if held for more than one year. Other equity-oriented funds, including international funds, attract long-term capital gains tax of 12.5% if held for over 24 months.

If a gold ETF is sold after 12 months, the gains are treated as long-term capital gains and taxed at a flat rate of 12.5%. However, in the case of gold and silver fund-of-funds, investors need to hold the investment for 24 months to qualify for long-term capital gains.

How Are Dividends in Mutual Funds Taxed?

Investors who opt for the Income Distribution cum Capital Withdrawal (IDCW) option should note that the income received is fully taxable. It is added to the investor’s total income and taxed according to the applicable income-tax slab rate. This applies to equity, debt and hybrid mutual fund schemes.

How Can Investors Use Mutual Fund Products to Maximise Tax Efficiency?

Financial planners suggest that investors utilise the long-term capital gains exemption of up to 1.25 lakh per year. Investors seeking tax-efficient fixed income options may consider arbitrage funds and income plus arbitrage funds. Hybrid schemes may also be used depending on the investor’s risk profile.

Prashant  Mahesh

 Source: The Economic Times