Skip to main content

How Tax impacts your Mutual Fund Returns

How tax impacts your mutual fund returns

 

 

Investors often tend to ignore the impact of taxes on their investment planning. Taxes, however, have a significant impact on the returns earned by the investor and therefore investors should pay due attention to the tax treatment of their investment returns and plan their investments accordingly. In this article, we will discuss mutual fund taxation. We will also discuss several strategies that will help you minimize taxes in different situations.

Before we get into nuts and bolts of mutual fund taxation, let us discuss the two different kinds of income from mutual funds:-

  1. Capital Gains: Capital gain is the appreciation in the value of the units of the mutual fund at the time of the sale. From a tax standpoint, there are two types of capital gains.



·        Short term capital gain: If the units are sold within a year of their purchase, then it leads to an incidence of short term capital gain.

 

·        Long term capital gain: If the units are sold at least after one year of their purchase, then it leads to an incidence of long term capital gain.

  1. Dividends: Dividends are profits returned by the mutual fund to the investor at regular intervals. However, the intervals are not certain and dividend amount is also not fixed.

The tax treatment of capital gains and dividend incomes are different. Tax treatment is also for different types of mutual funds. We will discuss the taxation of different categories of mutual funds separately.

Equity Funds

From a tax perspective, a fund in which at least 65% of the portfolio is allocated to equities is an equity fund. Therefore, other than the usual equity funds, like diversified equity funds, ELSS etc, balanced funds with more than 65% of its portfolio allocated to equities, is also categorized as equity funds from a tax standpoint. However, mutual funds like monthly income plans, which usually have a much smaller allocation to equities, are not categorized as equity funds. Short term capital gains (if the units are sold before one year) in equity funds are taxed at the rate of 15%. There is no tax on long term capital gains of equity fund. Dividends of mutual funds are tax free in the hands of the investors. However, depending on the type of mutual funds, mutual funds may have to pay dividend distribution tax, before giving dividends to the investors. For equity funds, the dividend distribution tax is zero. Here is a quick recap of tax treatment of equity funds.

Debt Funds (excluding money market and liquid funds)

From a tax perspective, a fund in which less than 65% of its portfolio allocated to equities is a debt fund. Short term capital gains (if the units are sold before one year) in debt funds are taxed as per the applicable tax slab of the investor.

The income tax rates for individuals and Hindu Undivided Families are as follows:-

So if your taxable income is above Rs 10 lakhs then short term capital gains tax of a your debt fund is 30%. Long term capital gains of debt fund are taxed at 10% without indexation and 20% with indexation. To calculate capital gains with indexation, you should index your purchasing cost by multiplying the purchasing cost with the ratio of the cost of inflation index of the year of sale and cost of inflation index of the year of purchase, and then subtract the indexed purchasing cost from sales price. Effective June 1 2013, dividend distribution tax (payable by the fund) on dividends given by debt funds (except money market and liquid funds) is 12.5% plus 10% surcharge plus 3% cess. The dividend distribution tax works out to be 14.1625%. The fund pays dividends to the investors, after deducting dividend distribution tax.

Choosing between growth and dividend option?

If your investment horizon in a debt fund is less than a year, you should let your tax status determine the choice between the growth option and dividend or dividend re-investment option. If you fall in the 10% tax slab, then you should opt for the growth option. If you are in the 20% or 30% tax slab, you should opt for the dividend or dividend re-investment option (please see the table below).

Here is a quick recap of tax treatment of debt funds, excluding money market and liquid funds.

Liquid Funds

From a tax perspective, liquid funds and ultra short term debt funds constitute money market and liquid funds. Short term capital gains (if the units are sold before one year) in liquid funds are taxed as per the applicable tax slab of the investor. Long term capital gains of debt fund are taxed at 10% without indexation and 20% with indexation. Effective June 1 2013, dividend distribution tax (payable by the fund) on dividends given by money market and liquid funds, is 12.5% plus 10% surcharge plus 3% cess. The dividend distribution tax works out to be 28.325%. The fund pays dividends to the investors, after deducting dividend distribution tax.

Choosing between growth and dividend option?

Like other debt funds, you should let your tax status determine the choice between the growth option and dividend or dividend re-investment option, if your investment horizon is less than a year. If you fall in the 30% tax slab, then you should opt for the dividend or dividend re-investment option. If you are in the 10% or 20% tax slab, you should opt for the growth option. The table below summarizes the tax consequence of growth and dividend options in liquid funds, for various tax slabs.

Here is a quick recap of tax treatment of money market and liquid funds.

Gold Funds

Tax treatment of Gold ETFs and Gold fund of funds is the same as debt funds excluding money market and liquid funds

Arbitrage Funds

Arbitrage funds aim to give risk free returns to the investors. Since arbitrage funds are risk free by definition, they are often compared to liquid funds. Over the past one year or so, arbitrage funds have given as much returns as liquid funds. However, the tax treatment of arbitrage funds is same as equity funds. If you opt for the dividend option in an arbitrage fund, then the fund does not have to pay dividend distribution tax, unlike debt and liquid funds. If you hold your arbitrage fund for over a year, the long term capital gains tax is nil. Debt and liquid funds, on the other hand, are subject to long term capital gains tax of 10% without indexation and 20% with indexation. Even though arbitrage funds are more tax friendly compared to debt and liquid funds, one should note that returns of arbitrage funds are contingent upon the availability of arbitrage opportunities in the market. We will discuss arbitrage funds, in a subsequent article.

Conclusion

In this article, we have discussed the effect of taxes on your mutual fund investment. Tax saving or tax reduction should never be your ultimate investment objective. Your investment objective should be determined by your personal financial goal, as discussed in our article, How will personal Financial Planning help you. However, you should pay due attention to the impact of taxes on your investments and plan your investments accordingly, so that you achieve your investment objectives by maximizing the post tax returns on your investment. You should discuss the most tax efficient investment options for you with your financial adviser.

For further information contact Prajna Capital on 94 8300 8300 by leaving a missed call

Leave a missed Call on 94 8300 8300

Leave your comment with mail ID and we will answer them

OR

You can write back to us at

PrajnaCapital [at] Gmail [dot] Com

---------------------------------------------

Invest Mutual Funds Online

Invest Any Mutual Fund Online

Download Mutual Fund Application Forms from all AMCs

Download Mutual Any Fund Application Forms

---------------------------------------------

Best Performing Mutual Funds

    1. Largecap Funds Invest Online
      1. DSP BlackRock Top 100 Fund
      2. ICICI Prudential Focused Blue Chip Fund
      3. Franklin India Bluechip
      4. ICICI Prudential Top 100 Fund

B. Large and Midcap Funds Invest Online

      1. ICICI Prudential Dynamic Plan
      2. HDFC Top 200 Fund
      3. UTI Dividend Yield Fund
      4. Birla Sun Life Front Line Equity Fund
      5. Franklin India Prima

C. Mid and SmallCap Funds Invest Online

      1. Reliance Equity Opportunities Fund
      2. DSP BlackRock Small & Midcap Fund
      3. Sundaram Select Midcap
      4. IDFC Premier Equity Fund
      5. Birla Sun Life Dividend Yield Plus
      6. SBI Emerging Businesses Fund
      7. HDFC Mid-Cap Opportunities Fund
      8. ICICI Prudential Discovery Fund

D. Small and MicroCap Funds Invest Online

      1. DSP BlackRock MicroCap Fund
      2. Franklin India Smaller Companies

E. Sector Funds Invest Online

      1. Reliance Banking Fund
      2. Reliance Banking Fund
      3. ICICI Prudential Banking and Financial Services Fund

F. Tax Saver Mutual Funds Invest Online

1. ICICI Prudential Tax Plan

2. HDFC Taxsaver

      1. DSP BlackRock Tax Saver Fund
      2. Reliance Tax Saver (ELSS) Fund

G. Gold Mutual Funds Invest Online

      1. Relaince Gold Savings Fund
      2. ICICI Prudential Regular Gold Savings Fund
      3. HDFC Gold Fund
      4. Birla Sun Life Gold

H. International funds Invest Online

1. Birla Sun Life International Equity Plan A

2. DSP BlackRock US Flexible Equity

3. FT India Feeder Franklin US Opportunities

4. ICICI Prudential US Bluechip Equity

5. Motilal Oswal MOSt Shares NASDAQ-100 ETF

Popular posts from this blog

Mutual Fund Exit Load Changes

Download Tax Saving Mutual Fund Application Forms Invest In Tax Saving Mutual Funds Online Buy Gold Mutual Funds Leave a missed Call on 94 8300 8300 Mutual Fund Exit Load Changes AMCs don't communicate about any change in exit load directly with investors, but do update on their website   The exit load applicable to your investments is the load which existed at the time when you invested in the particular fund. Any subsequent changes in the exit load will not be applicable to your investments.   However, Asset Management Companies ( AMCs ) periodically publish addendums in the newspapers, which state any change in exit loads of specific schemes managed by them. Such changes are also posted on their websites. However, a direct communication to an investor is not made, considering the costs involved in doing so. In their own interests, investors should not only track the performance of the funds they i...
Read more

Birla Sun Life Mutual Fund Launches Birla Sun Life NIFTY ETF

Birla Sun Life has launched a new fund namely, Birla Sun Life Nifty ETF, an open ended exchange traded fund. The new fund will be open for subscription from 4th July to 18th July 2011, at an offer price of Rs 10 per unit. The investment objective of the scheme is to generate returns that closely correspond to the total returns of securities as represented by S&P CNX Nifty, subject to tracking errors. No exit load will be charged under the scheme. The performance of the scheme will be benchmarked against S&P CNX Nifty and will be managed by Satyabrata Mohanty.   -----------------------------------------------------------------   Also, know how to buy mutual funds online:   1) DSP BlackRock Mutual Funds: http://prajnacapital.blogspot.com/2011/05/buying-dsp-blackrock-mutual-funds.html   2) Reliance Mutual Funds: http://prajnacapital.blogspot.com/2011/06/buying-reliance-mutual-funds-online.html   3) Birla Sunlife Mutual Funds: http://prajnacapital.blogspot.com/2011/...
Read more

Atal Pension Yojana contribution Tax Benefit for spouse

Contributions to Atal Pension Yojana (APY) are eligible for the same tax benefits as the NPS. This means that the contributions can be claimed under Section 80CCD (1B). The current limit for Section 80CCD (1B) is   Rs   50,000, over and above the   Rs   1.5 lakh limit under Section 80C. Section 80 CCD (1) is a different one, meant to cover employers' contribution towards NPS . You cannot get tax benefit by investing in the name of your spouse under Section 80 CCD . ------------------------------ ----------------- Invest Rs 1,50,000 and Save Tax under Section 80C. Get Great Returns by Investing in Best Performing ELSS Mutual Funds Top 10 Tax Saver Mutual Funds to invest in India for 2016 Best 10 ELSS Mutual Funds in India for 2016 1. BNP Paribas Long Term Equity Fund 2. Axis Tax Saver Fund 3. Religare Tax Plan 4. DSP BlackRock Tax Saver Fund 5. Franklin India TaxShield 6. ICICI Prudential Long Term Equity Fund 7. IDFC Tax Advantage (ELSS) Fund 8. Birla Sun Life Tax Relief 96 9. ...
Read more

Short-Term Investment Options in Mutual Funds

Mutual funds offer liquid funds and ultra short term funds in the debt category, which are suitable for short investment periods. Ultra short-term funds were earlier known as liquid plus funds. Liquid funds invest in money market instruments with a maturity of 91 days or less. However, there are no such restrictions for ultra short-term funds. Who should invest in these? These are open-ended schemes. Investors with a short investment horizon or with surplus cash and low risk appetite should look at these. These could include corporate as well as retail investors. Those interested in staying invested for less than 15 days can opt for liquid funds. Retail investors who want to remain invested for two-four months, can look at ultra short-term funds. The short duration for both liquid and ultra short-term funds shields them from any interest rate volatility.   What kind of returns do they offer? In terms of an investment period less than 15 days, these funds are comparable to a ba...
Read more

Mutual Fund Reivew: Birla Sun Life Asset Allocation Conservative

Birla Sun Life Asset Allocation Conservative has numbers on its side to prove its credibility… Don't be surprised to find this Fund of Funds ( FoF ) in our recommendations. It has earned its place. And despite the difference in the structure of the product, there is no arguing with the numbers.   Of the total 6 years of its existence, the fund has been among the top 10 funds in its category in four of them. Last year it put up an average show and the only year it underperformed its peers was in 2008.   One aspect to look at when investing in an FoF is the expense ratio. The expense ratio of an FoF is capped at a lower limit of 0.75 per cent (2.50% for an actively managed fund). However, the FoF not only has its own expense (though lower) but even the expense ratio of the fund it is investing into. Fortunately, the fund manager takes that into account. "Expense is one of the important criteria used for fund selection and is the main reason for our investment in BSL Ind...
Read more
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now