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Capital Gain Tax on Mutual Funds

 Capital Gain simply means "Appreciation in the value of asset". Let's say you bought few shares of Reliance for Rs. 1 lakh and sells it for Rs.2 lakhs, you have made a Capital Gain Rs. 1 lakh. This capital gain comes under the purview of Income Tax Act and is taxable under the head of Capital Gain.

The applicable rate of tax is decided by the period of holding, i.e. short term and long term.

Mutual Fund is further divided into two parts

  • Equity Mutual Fund
  • Debts Mutual Fund

Before Diving into the taxation part first we want to attract our reader's attention towards the meaning of both types of Mutual Fund.

Equity Mutual Funds

Equity mutual fund means a fund where the investible corpus is invested by way of equity shares in Indian companies to the extent of more than 65% of the total proceeds of the fund, so even balanced funds will be categorized in Equity Funds.

 

Debt Mutual Funds

All the other funds which do not fit into the definition of Equity Mutual Funds, including Fund of Funds (mutual funds which invests in other funds) and International Funds (funds which have more than 35% exposure to international equities) will be kept under debt category for tax purpose.

Taxation on Mutual Funds under Capital Gain in India

Capital Gain Tax on Equity Mutual Funds

The Capital Gain is divided into two parts according to holding period.

Long Term Capital Gain: If the holding period of Mutual Fund exceeds 1 year, then it is categorized as Long Term asset and there will be no tax at the time of redemption of mutual fund units. Suppose you invested 1 lakh in UTI Mutual Fund and sold it after 1 year for Rs. 1.4 lacs, then there will be no tax on the appreciated value of UTI fund of Rs. 40,000.

LTCG is tax-free for equity mutual funds under section 10(38).

Short Term Capital Gain: If the mutual funds are held for less than 1 year i.e. you bought and sold mutual fund within a year, then it is categorized under Short Term asset and the Capital Gain arises shall be taxable @ 15% under section 111A of Income Tax Act.

In the above example, if you had sold UTI fund within 1 year then there will be tax liability of Rs.6,000 (15% on Rs.40,000) as Short Term Capital Gain.

Note for NRIs: Long Term Capital Gain is also exempted for NRIs but in case of Short Term Capital Gain there will be a TDS (tax deducted at source). Which means Tax will be deducted by Mutual Fund Company before paying redemption (sell) amount, which is 15%.

Capital Gain Tax on Debt Mutual Funds

Short Term Capital Gain: The gain arises due to redemption of debt mutual fund within 3 year (earlier 1 year) shall be added in the income of investor and tax will be charged at the rate according to the tax slab.

Suppose Mr. Sanyam has Income from house property Rs. 3 lacs and income from debt mutual fund Rs. 30,000. Then the total tax shall be 10.30% (10% slab rate + 3% Cess) on Rs.1,30,000 (Rs.3,00,000 + Rs.30,000 – Rs.2,00,000) i.e. Rs.13,390.

Long Term Capital Gain: Selling of mutual fund units after holding for 3 years falls in the category of long term but unlike equity mutual funds, the benefit of exemption under section 10(38) is not available in debt mutual fund. Any long term gain arises from the sell/redemption of debt mutual funds shall be taxable at the flat rate of 20% (plus 3% cess) after claiming benefit of Indexation.

Note for NRIs – NRIs will receive their redemption amount only after tax:

  • Short Term – 30% TDS + 3% Cess
  • Long Term – 20% TDS + 3% Cess

Taxation of Dividend paying Mutual Funds

Tax on dividend paying Equity Mutual Funds:

The dividend received in hands of unit holder for an equity mutual fund is completely tax free. The dividend is also tax free to the mutual fund house. This means, the fund house is also not liable to pay any tax on the dividend received. Thus for equity mutual fund, dividend is tax free for both—unit holder and fund house.

Tax on dividend paying Debt Mutual Funds:

The dividend income received by a unit holder on his debt mutual fund is also tax free. But, the mutual fund company has to pay a dividend distribution tax (DDT) before distributing this income to its investors.

Here's a broad summary table of the information covered in the article above.

Type of Mutual Fund Definition of Short term & Long term Short term Cap gain Treatment Long term Cap gain Treatment Dividend Distribution Tax (DDT)(paid by MF house/company)
Equity Mutual Funds Less than 365 days is Short Term. 15% taxation under section 111A Nil (Exemption under section 10(38) Nil (No DDT Payable as per section 115R)
365 days or more is Long Term.
Debt Mutual Funds(non Liquid schemes) Less than 3 years is Short Term. Taxed as per individual tax slab of the investor 10% without indexation OR20% with indexation, plus 3% cess 12.5% plus 5% surcharge plus 3% cess, totally 13.519%(under section 115R)
3 years or more is Long Term.
Money Market and Liquid Schemes Less than 365 days is Short Term. Taxed as per individual tax slab of the investor 10% without indexation OR 20% with indexation, plus 3% cess 25% plus 5% surcharge plus 3% cess, totally 27.038%
365 days or more is Long Term.
Gold ETFs Same as Debt Mutual Funds Same as Debt Mutual Funds Same as Debt Mutual Funds Same as Debt Mutual Funds

It is important to have an understanding of DDT, as it is investors who have to bear burden of such taxes.

Rates of DDT on Debt Mutual Fund are as follows:

For an individual / HUF and NRI, DDT is 13.519% (12.5% + 5% surcharge + 3% cess).

DDT for money market & liquid MF

A liquid / Money Market scheme attract more DDT than a normal debt MF, and are taxed at the rate 25 % plus surcharge (5%) and education cess (3%), which effectively amounts to 27.038%.

Type of scheme Rate of DDT for individuals, HUF & NRI
Equity oriented MF schemes Nil
Debt schemes 13.519%
Liquid / money market schemes 27.038

In addition to DDT, a scheme also pays securities transaction tax at the applicable rates (0.1% for FY12-13) at the time of buying and selling equity shares or derivatives on the recognized stock exchange

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