How are Mutual Funds taxed?

Mutual Fund investors make gains by way of capital appreciation and dividends. The gains you make from your mutual fund investments are taxed.
The tax rates depend on the fund category and the investment holding period. Holding period is the tenure for which an investor stays invested in the mutual fund scheme. The holding period can be short term or long term.
Let’s discuss the taxation applicable with an illustration.
Equity Funds
Equity funds are mutual funds in which at least 65% of the assets are invested in equity and equity related instruments. This includes Equity Linked Savings Scheme (ELSS) as well.
For more about equity mutual funds, read this blog.
Short term capital gain: When the holding period of the investment is up to 1 year, it is considered as short term. Short term capital gains tax of 15% on the gain amount is applicable.
Illustration:
- Shweta invests Rs 10,000 in an Equity Mutual Fund at an NAV of Rs 25 in November 2018.
- She gets 400 units (Rs 10000 divided by Rs 25) allocated.
- NAV grows to Rs 30 by June 2019. The value of her investment is Rs 12,000 (Rs 30 multiplied by 400)
- Shweta redeems the amount and she gets a gain of Rs 2000 (Rs 12,000 minus Rs 10,000)
- STCG will be Rs 300 which is 15% tax on the gain of Rs 2000
Exit load is not considered in the illustration as it may vary from fund to fund
Long term capital gain: When the holding period of the investment is more than 1 year, it is considered as long term. Long term capital gains tax of 10% on the gain amount in excess of Rs 1 lakh is applicable.
Illustration:
- Shweta invests Rs 5,00,000 in an Equity Mutual Fund at an NAV of Rs 25 in November 2012.
- She gets 20,000 units (Rs 5,00,000 divided by Rs 25) allocated.
- NAV grows to Rs 35 by June 2019. The value of her investment is Rs 7,00,000 (Rs 35 multiplied by 20,000)
- Shweta redeems the amount and she gets a gain of Rs 2,00,000 (Rs 7,00,000 minus Rs 5,00,000)
- Shweta has to pay 10% capital gain on the gains exceeding Rs 100,000. In this case, she must pay Rs 10,000 as LTCG ((200000 – 100000) * 10%)
Debt Funds
Debt mutual funds are those that invest in fixed income instruments – such as corporate and government bonds, overnight securities, corporate debt securities, money market instruments etc. These funds are ideal for investors who are averse to risk and seek to generate regular income. For more about debt funds, read this blog.
Short term capital gain: When the holding period of the investment is up to 3 years, it is considered as short term. Short term capital gains tax is applicable as per the income tax slab of the individual.
Illustration:
- Shweta invests Rs 10,000 in a Debt Mutual Fund at a NAV of Rs 25 in November 2018.
- She gets 400 units (Rs 10,000 divided by Rs 25) allocated.
- NAV grows to Rs 31 by June 2021. The value of her investment is Rs 12,400 (Rs 31 multiplied by 400)
- Shweta redeems the amount and she gets a gain of Rs 2400 (Rs 12,400 minus Rs 10,000)
- Assuming she is in the 30% tax bracket, her STCG will be Rs 720 which is 30% tax on the gain of Rs 2400
Exit load is not considered in the illustration as it may vary from fund to fund
Long term capital gain: When the holding period of the investment is more than 3 years, it is considered as long term. Long term capital gains tax of 20% is applicable on the gain amount after taking into consideration the cost of indexation.
Indexation adjusts your investment amount for inflation, and tax on gains are calculated on the adjusted investment amount.
Illustration:
- Shweta invests Rs 50,000 in a Debt Mutual Fund at a NAV of Rs 25 in November 2012.
- She gets 2000 units (Rs 50,000 divided by Rs 25) allocated.
- NAV grows to Rs 35 by Feb 2019. The value of her investment is Rs 70,000 (Rs 35 multiplied by 2000)
- Shweta redeems the amount and she gets a gain of Rs 20,000 (Rs 70,000 minus Rs 50,000)
- Taxes are computed using the Cost Inflation Index (CII)
- The CII for the financial year 2012-2013 was 200 and for 2018-2019 was 280
- Amount invested will be adjusted for inflation and it is recalculated as Rs 70,000 (280/200 * 50,000)
- Shweta has to pay 20% as taxes on the difference between the value at the time of withdrawal and the indexed cost. Tax here will be NIL as the gain is zero (Rs 70,000 – Rs 70,000)
To summarize
Short Term Capital Gain | Long Term Capital Gain | |
Equity Mutual Funds | 15% | 10% over and above Rs 1,00,000 |
Holding Period | < 1 year | >= 1 year |
Debt Mutual Funds | Based on tax slab | 20% with indexation |
Holding Period | < 3 years | >= 3 years |
For hybrid mutual funds, those that have at least 65% equity will be taxed as equity mutual funds, and the rest as debt mutual funds.
Dividend income from shares, debt, equity, and other non-equity MF
- Tax is not applicable on dividend income
- However, Mutual Funds deduct the Dividend Distribution Tax (DDT) from the NAV and pay it to the government
- The effective rate of DDT is 29.12% including the surcharge and cess for non-equity funds and 11.64% for equity funds
If you are a resident Indian, TDS (Tax Deducted at Source) will not be applicable when you sell your units. You must declare the income and pay taxes, if any, when you file your returns. If you are a non-resident Indian, while the tax laws remain the same for capital gains, TDS will be deducted, at the applicable rates, when you redeem.
Remember that even when you are switching units from one scheme to another or from the one option to another, or making an STP or a SWP, they will all be considered as redemptions.
Taxes are also one of the many factors you should consider when choosing a mutual fund. Consult a tax or other advisor accordingly.