Benjamin Franklin once said that, the only two certainties in life are death and taxes. Death is unavoidable, but taxes can be reduced under certain circumstances, provided you understand the tax laws of the country you are living in and make the right investment decisions.
Unfortunately, even though investments in mutual funds in India are growing by leaps and bounds, many investors do not know what is the tax on mutual fund income in India and that could be a potential risk that the investors might end up paying more taxes (getting lower returns) than expected or he or she might not disclose the correct taxable income while fling the Income Tax Returns (ITR).
Mutual funds are one of the most tax friendly investment options for investors in India. Did you know what are tax savings mutual funds in India? Various tax benefits of mutual funds makes it a better option compared to most traditional investment options like bank fixed deposits, postal saving schemes etc.
If we talk about tax on mutual fund income in India, they are mainly of 3 types –
- Long term capital gains
- Short term capital gains
- Tax on dividend income
However, tax on mutual fund income in India also depends not only on the nature of the income but also on the type of funds (equity or non-equity funds) from which the said income is received.
- Long term capital gain: Capital gain is the appreciation in the value of the units of a mutual fund scheme at the time of redemption or sale.
If equity mutual fund units are sold after more than 12 months from the date of investment, then it leads to long term capital gain which is totally tax free.
If non-equity mutual fund units are sold after more than 36 months from the date of investment, then it leads to long term capital gains. Long term capital gains of debt funds are taxed at 20% after allowing indexation.
To calculate capital gains with indexation for non-equity funds, you should index your purchasing cost by multiplying the purchasing cost with the ratio of the cost of inflation index of the year of sale and cost of inflation index of the year of purchase, and then subtract the indexed purchasing cost from sales value.
No long term capital gains tax on mutual fund income in India in case of equity mutual funds and only 20% capital gains tax post indexation in case of non-equity funds is one of the biggest tax benefits on mutual fund income in India.
- Short term capital gain: If the mutual funds units are sold within the period defined under tax laws – for equity funds, short term capital gain period is defined as within 12 months from the date of investment and in case of non-equity funds the short term capital gain period is defined as, within 36 months from the date of investment.
Short term capital gains (if the units are sold/ redeemed before one year) in equity mutual funds are taxed at the rate of 15% +Cess.
Short term capital gains (if the units are sold/ redeemed before 3 years) in non-equity mutual funds are taxed as per applicable tax rate of the investor. So if your taxable income is above Rs 10 lakhs then short term capital gains tax of your non-equity fund sale is 30% + applicable Cess and surcharges.
Lower short term capital gains tax on mutual fund income in India is another benefit for which it is a preferred choice for the investors.
Did you know what the different types of debt mutual funds are and how they work?
- Dividends: Dividends are profits returned by a mutual fund scheme to the investor at periodic intervals. However, the intervals or the frequency of the dividend payment and also the dividend amount is not fixed.Dividends received from equity and non-equity mutual funds in the hands of the investor are totally tax free.Therefore, on tax on mutual fund income in India by way of dividends received from equity mutual funds makes it a very attractive proposition.
However, in case of non-equity mutual funds (debt, Gilt and Gold funds etc.), the dividend distribution tax (DDT) has to be paid by the mutual fund scheme and therefore, it has an impact on the final dividend received by the investor. Currently the Dividend Distribution Tax (DDT) on dividends declared by non-equity/ debt fund schemes is 25% plus 12% surcharge plus 3% Cess. i.e. total 28.84% in case of individual investors.
The above makes a big benefit of having mutual fund income in India by way of dividends. This makes huge impact on the income of an individual as neither he or she need to pay any tax on the dividends received from mutual funds nor there is any TDS (tax deduction at source) unlike interest earned on fixed deposits.
Mutual funds are among the most tax efficient investment options for investors as such they should educate themselves about the tax on mutual fund income in India and how the tax benefits available on it vis a vis other investment options. This will help investors make the best investment decisions for their short term and long term investment needs.
You may also like to read what are advantages and disadvantages of mutual funds in India