How are mutual funds taxed?

A Mutual Fund (MF) is formed when capital collected from various investors is used to purchase company shares, stocks, or bonds. Shared by a bunch of investors, mutual fund investments are collectively managed by a certified fund manager to earn the best possible returns. There are a lot of advantages of investing in mutual funds. Some of the key benefits and advantages of investing in mutual funds include simplicity, professional management, cost, diversification, etc.

The primary purpose of investing is to accumulate wealth in the form of dividends, interest, or capital gains. This income that you earn through investments attracts income tax as well. The tax required to pay on capital gains depends on the duration for which you stay invested in the security. This duration is termed as the holding period of mutual funds. It is the duration you hold an investment from the time of purchase to its sale. There are two types of holding periods- long term holding periods and short term holding periods. A long-term holding period involves one year or more with no expiration. Whereas, a short-term holding period is less than one year.

Different mutual funds have different taxation. Following are the taxation on some of the varied mutual funds:

  • Tax-Saving Equity Funds

Equity-Linked Saving Scheme or commonly called as ELSS are tax-saving mutual funds that invest in equity shares of various companies across market capitalization. Usually, an ELSS fund has a lock-in period of three years. Post redemption, you have access to long-term capital gains (LTCG) up to Rs1 lakh, which are free of taxation. Individuals invest in ELSS to save taxes while simultaneously growing their wealth.

  • Non-Tax Saving Equity Funds

Long-term capital gains (LTCG) on non-tax saving equity funds up to Rs 1 lakh is tax-free. LTCG above Rs 1 lakh is taxable at 10% without any advantage of indexation. Indexation is a technique that involves factoring the increase in inflation from the time of purchase to sale of the units.

  • Debt Funds

Long-term capital gains on debt funds are taxable at 20% after indexation. Indexation permits inflating the purchase price of debt funds to bring down the quantum of capital gains. You have to add short-term gains from debt funds to your overall income. They are subject to short capital gains tax (SCGT) as per the income tax slab you represent.

  • Balanced funds

Balanced funds are equity-oriented hybrid funds that usually invest at least 65% of their assets towards equities. The tax treatment on balanced funds is almost the same as non-tax saving equity funds.

  • SIPs

A systematic investment plan or a SIP invests a pre-determined amount in a mutual fund in a periodic manner. The SIP may be daily, weekly, fortnightly, monthly, or even quarterly. Gains from SIPs are taxable as per the type of mutual fund you invest in and its holding period. Each SIP, treated as a brand new investment, attracts taxes on its gains separately.

  • Securities Transaction Tax (STT)

Lastly, there is another type of tax called – Securities Transaction Tax or STT. An STT of 0.001% is charged by the fund manager when you decide to sell your units of an equity fund or balanced fund. Also, there is no STT on the sale of debt fund units.

Whether you decide to invest in tax-saving investments such as ELSS mutual funds or non-tax-saving investments, you should always consider your financial goals, risk profile and investment horizon.Happy investing!

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