How Mutual Funds Returns Are Taxed?

Investing in mutual funds offers a simple and effective way to grow your wealth. However, it’s essential to understand how mutual fund returns are taxed in India to make informed investment decisions. This article aims to simplify the complex world of mutual fund taxation, using easy-to-understand language for Indian investors.

Understanding Mutual Fund Returns

Before talking about taxation, let’s know how mutual fund returns work. Mutual funds pool money from multiple investors to invest in various assets like stocks, bonds, or a combination of both. The returns generated from these investments are distributed among investors in proportion to their investment.

Types of Mutual Funds

In India, mutual funds are classified into two main categories for taxation purposes: equity-oriented funds and debt-oriented funds.

1. Equity-Oriented Funds:

• These funds primarily invest in equity shares of companies.
• Examples include equity mutual funds and equity-linked saving schemes (ELSS).
• They have a holding period of at least one year to qualify for long-term capital gains (LTCG) taxation benefits.

2. Debt-Oriented Funds:

• These funds primarily invest in fixed-income securities like bonds and debentures.
• Examples include debt mutual funds and fixed maturity plans (FMPs).
• They have a holding period of at least three years to qualify for LTCG taxation benefits.

Taxation of Mutual Fund Returns:

Now, let’s explore how the returns from mutual funds are taxed in India.

1. Equity-Oriented Funds:

• Short-Term Capital Gains (STCG): If you sell equity-oriented mutual fund units within one year of purchase, the gains are considered short-term and taxed at a flat rate of 15% plus applicable cess.
• Long-Term Capital Gains (LTCG): If you sell equity-oriented mutual fund units after holding them for more than one year, gains exceeding Rs. 1 lakh in a financial year are taxed at a rate of 10% plus applicable cess, without the benefit of indexation.

2. Debt-Oriented Funds:

• Short-Term Capital Gains (STCG): If you sell debt-oriented mutual fund units within three years of purchase, the gains are considered short-term and taxed at your applicable income tax slab rates.
•  Long-Term Capital Gains (LTCG): If you sell debt-oriented mutual fund units after holding them for more than three years, gains are taxed at a rate of 20% with indexation or 10% without indexation, whichever is lower.

Dividend Distribution Tax (DDT):

For both equity-oriented and debt-oriented funds, dividends distributed by mutual funds are subject to dividend distribution tax (DDT) before being paid to investors. However, in the Union Budget 2020, DDT was abolished, and dividends became taxable in the hands of investors at their applicable income tax slab rates.

Understanding how mutual fund returns are taxed is crucial for investors to plan their investment strategies effectively. By knowing the tax implications, investors can optimize their returns and minimize tax liabilities. Remember to consult with a financial advisor or tax expert for personalized advice tailored to your financial goals and circumstances. Happy investing!