VMPL
New Delhi [India], November 27: You have worked hard to save and have decided to invest in mutual funds to grow your wealth. After months of watching your investments grow, you suddenly realise that the returns you earned could be subject to taxes. Now, you are left wondering: what exactly does that mean for your investment?
Mutual fund taxation is something many investors overlook, but it's essential to understand it so you can maximise your returns and avoid surprises when it's time to file your taxes.
Taxation on Different Types of Mutual Fund Schemes
Equity Funds
Equity mutual funds are investment avenues that park more than 60% of the capital into stocks of listed companies. Depending on the market capitalisation of the companies whose stocks the scheme holds, equity funds can be categorised into large-cap, mid-cap, small-cap, or flexi-cap schemes.
Capital Gains
The tax rates on short-term capital gains (STCG) and long-term capital gains (LTCG) for equity mutual funds have been updated. When you sell your equity mutual fund shares within a year, the profits are classified as short-term and are subject to a tax rate of 20%. For instance, if you invest Rs1,00,000 in an equity mutual fund through a SIP investment app and then sell your units after 8 months for Rs1,20,000, your profit would amount to Rs20,000. Here, a 20% STCG tax would apply, leading to a tax payment of Rs4,000 (calculated as Rs20,000 * 20%).
For long-term capital gains, which apply when you hold your units for over a year, the applicable tax rate is 12.5%. However, this rate is only levied on profits exceeding Rs1,25,000. For example, if you invest Rs2,00,000 in an equity mutual fund and later sell it for Rs3,50,000 after a year, your total gain would be Rs1,50,000. Since gains up to Rs1,25,000 are exempt from tax, you will only be taxed on the remaining Rs25,000. Thus, with a 12.5% tax rate, your tax obligation would amount to Rs3,125 (which is Rs25,000 multiplied by 12.5%).
Securities Transaction Tax
Equity mutual funds incur the Securities Transaction Tax (STT) alongside capital gains tax. This tax applies to the sale of units in equity-oriented mutual funds and is currently set at 0.001%. Although this rate appears minimal, it is an extra expense that you should factor into their investment strategies.
Equity Linked Savings Scheme
Equity Linked Savings Schemes (ELSS) focus on equity investments and provide both the chance for capital growth and tax benefits. For example, after you open Demat Account and put money into ELSS, you can deduct up to Rs1.5 lakh from your taxable earnings under Section 80C. For example, if you are in the 30% tax bracket, a Rs1.5 lakh investment could result in tax savings of up to Rs46,800 each year. This makes ELSS appealing to those who want to enjoy returns better than tax-saving options like the Public Provident Fund (PPF) or National Savings Certificate (NSC).
ELSS has a mandatory lock-in period of three years. That means if you invest on November 1st, 2024, you can redeem only after November 1st, 2027.
Debt Mutual Funds
Debt mutual funds are an investment avenue where the scheme's portfolio comprises fixed-income securities like commercial papers, treasury bills, bonds, and other debt instruments. The returns on debt funds depend on the underlying instruments' capital appreciation and interest rate.
Although their returns are lower than equity schemes, the stability they offer makes them a perfect choice for conservative investors.
Here is how they are taxed:
Investment After 1st April 2023:
If you invested in debt mutual funds through an investment app after 1 April 2023, regardless of your holding period, you are required to pay tax as per your current income tax slab rate. Your investment will not receive any indexation benefits.
For those unfamiliar, indexation adjusts the purchase price of an asset based on inflation, helping reduce the capital gains tax burden when the asset is sold.
Investment Before 1st April 2023:
Earlier, debt funds were taxed based on the holding period.
If you hold your investment for less than 24 months, you have to pay tax on the short-term capital gain based on your income tax slab rate. For example, if you fall under the 30% slab rate and the gains from your investment are Rs1,00,000, the tax applicable will be Rs30,000.
If you sell your debt mutual fund holdings after 24 months, the long-term capital gain will be taxed at 12.5% without indexation. Earlier, the long-term capital gain on debt mutual funds was 20% with indexation.
Hybrid Funds
The taxation on hybrid funds depends on their underlying securities. For example, if the scheme holds more than 65% of its securities in equity, it will be treated as an equity-oriented scheme and taxed accordingly. If more than 65% of the exposure is in debt instruments, it will be treated as a debt mutual fund for taxation purposes.
Understanding Dividend Distribution Tax on Equity Mutual Funds
The Finance Act 2020 removed the Dividend Distribution Tax (DDT) on 1st April 2020. Before its abolition, DDT was applied at the source. That means mutual fund companies were required to pay it before passing dividends to investors. For equity-oriented funds, the DDT rate stood at 10%, while debt-oriented funds faced a 25% rate, plus any applicable surcharge and cess.
The imposition of DDT had several implications:
Double Taxation: Companies or mutual funds paid tax before distributing dividends, and investors were taxed on their total income, resulting in double taxation.
Reduced Returns: The DDT deduction diminished the dividend amount that investors ultimately received, negatively affecting their overall returns on their investments.
Complexity in Taxation: Investors faced the challenge of understanding various tax rates for equity and debt funds, complicating their tax planning efforts.
Filing Your Taxes
When filing your taxes, you must accurately report your mutual fund investments. Keep track of all transactions, including each fund's purchase price, sale price, and holding period. Use Form 26AS and your mutual fund statement to help verify your capital gains. If you have significant capital gains, you may consult a chartered accountant to ensure you comply with tax laws and maximise your deductions.
Conclusion
Mutual fund taxation is vital for any investor looking to build wealth. You can make more informed investment decisions by grasping how different types of mutual funds are taxed, the implications of capital gains, and strategies to minimise your tax liability.
Additionally, you may explore investment strategies like a margin trading facility to amplify your returns. While it involves borrowing funds to trade more significant volumes, it's essential to fully understand the associated risks before proceeding.
(ADVERTORIAL DISCLAIMER: The above press release has been provided by VMPL. ANI will not be responsible in any way for the content of the same)