You have to pay capital gains tax on your gains or profits in mutual funds. Capital Gain is the basis of mutual funds taxation in India. If you get dividends from mutual funds, the mutual fund deducts Dividend Distribution Tax (DDT) from the dividend paid to you. However the mutual funds taxation rate varies according to the type of fund you have invested in and when you sell it. Read on.
Capital Gains based Mutual Funds Taxation
A capital gain is a difference between your purchase value and sale value. For instance, if you have invested Rs 1 lakh in a mutual fund and it is now valued at Rs 1.5 lakh, your capital gain is Rs 50,000. Mutual funds taxation will only apply on this gain, if you sell your units in the fund. There is no tax on unrealised or only accrued gain.
The mutual funds taxation depends on how long you have held the fund and what type of fund it is.
|Fund Type||Holding Period for Long Term||Short Term||Long Term|
|Equity Fund||1 year||15%||10%|
|Aggressive Hybrid Equity Fund||1 year||15%||10%|
|Other Hybrid Funds||If more than 65% of assets in equity, same as equity funds. Otherwise same as debt funds.|
|Debt Fund||3 years||Slab rate||20% with indexation|
|International Funds||3 years||Slab rate||20% with indexation|
Capital Gains Annual Exemption
Long-term capital gains on equity mutual funds are exempt up to Rs 1 lakh per annum. For example, if your long-term capital gains in FY 2018-19 are Rs 1.5 lakh, only Rs 50,000 will be taxable.
Gains before 1st February 2018
Earlier there was no long term capital gains tax on equity or hybrid equity funds. Budget 2018 introduced a 10% tax on long term capital gains in such funds but it exempted gains which had been made before 1st February 2018. This was called ‘grandfathering.’
For example assume that you invested Rs 1 lakh in an equity fund on 1st March 2016 and the same was valued at 1.8 lakh on 1st February 2016 and 2.2 lakh on 1st October 2019. The taxable gain is only the gain made after 1st February. Hence it is Rs 2.2 lakh – Rs 1.8 lakh = Rs 40,000.
Adjustment of Capital Gains
You can also adjust the gains in one fund against the losses in another mutual fund in the same year, if they are both short term or they are both long term. You can adjust short term capital losses against both long term and short term capital gains. You can adjust long term capital losses only against long term capital gains.
Indexation applies to long term capital gains in non-equity mutual funds. It reduces your tax rate to adjust for inflation. The taxable gain is reduced after factoring the Cost Inflation Index (CII) published by the Income Tax Department every year.
For example assume that you buy a debt fund in 2010 for Rs 100 and sell it in 2014 for Rs 150. Since you have sold it after three years, the gain is long term and a tax of 20% with indexation will apply. The Cost Inflation Index (CII) in FY 10 was 148 and the CII in FY 14 was 200. As a result your purchase price for tax purposes will rise to 200/148 = 135 and your taxable gain will be 150 – 135 = 15. The tax payable will be 20% of 15 = Rs 3. Hence even though you have made a gain of Rs 50, your actual tax is only 3 after applying indexation.
Equity fund dividends are taxed at 10%. Non-equity fund dividends are taxed at 28.84%. In both cases this tax called Dividend Distribution Tax (DDT) is deducted before paying you the dividend. Hence you do not have to pay any additional tax. However your actual returns will be reduced due to the DDT.
TDS On Mutual Funds
There is no TDS (Tax Deducted at Source) on mutual fund capital gains or dividends, except for NRIs. However, dividends are paid to you after deducting Dividend Distribution Tax (DDT). The entire tax is deducted before paying you the dividend and hence the dividend is not taxable in your hands.
NRIs face the same mutual funds taxation rates as resident Indians. However, TDS is deducted for them at the applicable tax rate. This is 15% for short term gains in equity funds and 10% for long term gains in equity funds. The TDS rate is 30% for short term gains in debt funds and 20% for long term term gains in non-equity funds.
Tax on ELSS Funds
Investing in ELSS funds is tax deductible for investments up to Rs 1.5 lakh per annum. These funds invest 80% of their assets in equity and enjoy a special tax status. ELSS funds also have a lock-in of three years. The gains on ELSS funds will be long term (you can only redeem after 3 years) and taxable at the long term capital gains tax of 10%. Dividends on such funds will also have Dividend Distribution Tax (DDT) deducted from them at 10%.
Tax on SIPs
The tax on SIPs depends on whether the SIP is in an equity fund or a non-equity fund. You can refer to the table above for the tax treatment of both. However what is distinct about SIPs in either equity or debt is that SIP investment is spread out into monthly installments.
As a result each installment has a different start date and completes one year to become long term (for equity funds) at a different date. For example an equity fund SIP that was started on 1st June 2018 and invested on the 1st of every month will complete one year for only the first installment on 1st June 2019. The second installment will complete one year on 1st July 2019 and so on. Hence if you sell your entire fund holding on 15th June 2019, only part of your investment will be long term (taxed at 10%) and most will be short term (taxed at 15%). The tax treatment is similar for SIPs in debt funds.
Securities Transaction Tax (STT)
Mutual Funds also deduct Securities Transaction Tax (STT) on equity funds and hybrid equity funds (those with more than 65%) when you sell a mutual fund. This is deducted at a rate 0.001%. You do not have to pay it separately but it will reduce your returns to a small extent.