We know that a certain part of our earning goes to the government in the form of Tax. Well, paying taxes is a good thing as indirectly by paying taxes we are supporting the growth of the country’s economy and making the country a better place to live.
Now, the tax rate that will be charged to you when investing in Mutual Fund depends on broadly two factors i.e. the time for which you are invested and the type of fund you invest in. But for that, you need to know about the different types of Funds that are available to invest according to your investment objectives. And also when we talk about taxes one must know how they can enjoy tax benefits by saving money while paying them.
The different types of tax on mutual funds that you as an investor will have to pay when investing in Mutual Funds are given below :
Taxation on Gains from Mutual Funds
Before we look into the types of Funds and their tax policies. You as an investor must know that the gains that you earn by investing in Mutual Fund can be divided into Short Term Capital Gain (STCG) and Long Term Capital Gain (LTCG).
The difference between STCG and LTCG is nothing but the time for which you are invested. The time of investment specified for STCG and LTCG are different for different Funds.
The following table will give you a clear idea of the period of STCG and LTCG for different Mutual Fund:
| Fund Type | STCG period | LTCG period |
|---|---|---|
| Equity Fund | < 12 months | >= 12 months |
| Debt Fund | < 36 months | >= 36 months |
| Hybrid – Equity oriented Fund | < 12 months | >= 12 months |
| Hybrid- Debt oriented Fund | < 36 months | >= 36 months |
Tax on different types of mutual funds
1. Equity Fund
Equity Fund invests in the shares of different companies and in different proportions. These Funds are suitable for investors who have a medium to high-risk appetite and want to invest in the Long term.
Long Term Capital Gain (LTCG)
If you hold the units of Equity Funds for a period of more than or equal to 12 months, then the gain that you will earn will be termed as LTCG.
LTCG in Equity Funds is taxed above the minimum deduction of 1 Lakh at the rate of 10%. For example, If you earn Rs. 1,20,000 after 12 months of your investment in equity funds and then you redeem your units. You will have to pay a 10% tax only on Rs. 20,000.
Short Term Capital Gain (STCG)
If you hold the units for a period of less than 12 months, the gain you will earn will be termed as STCG. STCG is taxed at the rate of 15%.
Tax Benefits under section 80C of Income Tax Act, 1961
Equity Linked Saving Scheme (ELSS) invests a minimum of 65% of their total assets in equity instruments like the shares of different companies and is the only Scheme where you can get a tax exemption of up to Rs. 1.5 Lakhs under section 80C of Income Tax Act, 1961. ELSS has a lock-in period of 3 years i.e. you cannot redeem/sell your units within 3 years of the investment period.
2. Debt Funds
Debt Funds invests in fixed income securities like Government securities, Treasury Bills, Bonds, etc. These Funds are suitable for conservative investors and for those who want to earn stable returns.
Long Term Capital Gain (LTCG)
In Debt Funds, if you hold the units for a period of more than or equal to 36 months, then the gain that you earn is termed LTCG. LTCG in these funds is taxed at the rate of 20%.
Short Term Capital Gain (STCG)
You get STCG if you hold the units for less than 36 months. STCG in debt funds is taxed according to the tax slab you fall into. For example, Suppose you invested in a debt fund for 24 months, and then you decide to redeem your units and take the profits that you earn. The tax slab you fall into is 30%. So, the gains that you received will be taxed at the rate of 30%.
3. Hybrid Funds
Hybrid Funds invests in both equity and debt instruments in different proportions. In simple words, these funds are a mix of both equity and debt instruments. Now, Hybrid Funds can be broadly classified into two types i.e. Equity oriented Funds in which you get a minimum of 65% exposure to equity instruments, and Debt oriented Funds where you get an exposure of at least 65% in debt instruments.
So, the Hybrid Funds that provide higher exposure to equity instruments are taxed exactly as Equity Funds. And the Hybrid Funds that have a higher exposure to debt instruments are taxed exactly as Debt Funds.
Let’s say that you invested in Hybrid-equity oriented Fund that has maximum exposure to equity instruments for more than 1 year, then the gain that you earn after selling the units will be termed as LTCG and will be taxable at the rate of 10% over and above the minimum deduction of 1 Lakh.
Dividend Distribution Tax (DDT)
The dividend is a part of the profit earned by the Company, that the company gives to their shareholder as a sign of reward. DDT is only related to Equity Mutual Funds and Hybrid- equity oriented Funds as only they invest in the share of different companies. The Debt Funds and Hybrid-debt oriented funds do not provide any dividends to you.
So, when the company that is in the portfolio of your Equity Mutual Fund gives dividend, the Mutual Funds provides you with the same. However, the dividend that you get is taxed by the Fund house itself(which is known as Tax Deducted at Source) at the rate of 10% only if the dividend value exceeds Rs. 5000 which is known as Dividend Distribution Tax (DDT).
For example, suppose you earn a dividend of Rs. 3000, then no DDT will be deducted at source as it is less than Rs. 5000 and so you will get the full amount.
Securities Transaction Tax (STT)
As the name suggests, Security Transaction Tax (STT) is charged when you buy or sell the units of Mutual Funds. And like DDT, STT is also charged only for Equity and Hybrid- equity oriented Mutual Funds and not for Debt related Funds. STT is charged at the rate of 0.001% per transaction.
So for example if you buy 30 units of Equity Fund of approximately Rs. 1,00,000 then you will be charged an STT of Rs, 1 (1,00,000 * 0.001%).
Difference between Capital Gains and Dividend Distribution Tax
| Capital Gains Tax | Dividend Distribution Tax (DDT) |
|---|---|
| The gain that you earn by buying the units at a lower price and selling the same at a higher price is known as Capital Gain. | The dividend is paid out of the companies profit to the shareholders of that company as a sign of reward. |
| The Capital gain tax rates differ depending on the type of funds and the time for which you have invested i.e. whether short term or long term. | DDT is deducted at source at the rate of 10% for only equity-oriented Funds if the value of dividends exceeds Rs. 5000. |
| For example, if you earn STCG in Debt Funds, then the rate of tax that you have to pay on the gains depends on the tax slab you fall into. | For example, You earn a dividend of Rs. 4000 investing in an equity fund, then you won’t be charged with DDT as the value is less than Rs. 5000. |
FAQ’s
ELSS is a scheme that invests at least 65% of the total assets in equity instruments. This is the only scheme that offers a tax exemption of up to 1.5 Lakhs under section 80 C. ELSS has a lock-in period of 3 years i.e. you cannot redeem your units within 3 years of investing.
The rate of tax and the period of STCG and LTCG are the same, whether you are investing through SIP or Lumpsum investment.
LTCG on Equity Funds up to 1 Lakh is tax-free. And, ELSS offers you the exemption on tax up to 1.5 Lakhs under section 80C. Other funds and categories are taxable.
