Dividend and Capital gain Tax on Mutual Fund Redemption
Mutual funds are one of the most tax-efficient investment options available in India. The returns offered by mutual funds may fluctuate but generally offer a stable return in the long run as they are managed by competent fund managers. Both the returns and tax saving make them better as compared to other fixed-income investments like fixed deposits and bonds.
Mutual Fund Income and classification
Mutual funds offer incomes in two forms – Dividends and Capital gain tax on Mutual fund redemption.
Dividends are paid from the profits of the company. If a company has surplus profits and cash, it may decide to share it with the investors in the form of dividends. Investors receive dividends in proportion to the number of mutual fund units held by them.
A capital gain is the profit earned by an investor if the selling price of the security held by him is greater than the purchase price. In simple terms, capital gains are realised due to the appreciation or increase in the price of the mutual fund units.
Due to recent amendments in income tax law, both dividend and capital gain tax on mutual fund redemption are now taxable in the hands of the investors.
Mutual Funds can be classified into two categories under Income Tax:
Equity Mutual Funds – Funds that invest at least 65% in equity shares out of their total portfolio.
Debt Mutual Funds – Funds that invest less than 65% in equity shares out of their total portfolio.
Taxation of Income from Equity Mutual funds
Equity mutual funds are taxed in the same manner as equity shares are taxed.
Dividend income from equity mutual funds
It was exempt in the hands of investors up to 31st March 2020. It is taxable with effect from 1st April 2020. Dividend income is taxable under other sources of income as per the slab rates.
Long term capital gain on equity mutual funds
When any investment in equity mutual funds is sold after one year it is classified under long term capital gain or loss.
It was exempt up to 31st March 2018. It is taxable with effect from 1st April 2018 at the rate of 10% u/s 112A if the gains exceed Rs 1 Lakh in a financial year. Investments made up to 31st March 2018 and sold after that date will enjoy tax exemption to the extent of gains earned up to 31st March 2018.
Indexation is not available for long term Equity mutual funds. There is also a deduction of up to Rs. 1,50,000 on investment in certain long term equity mutual funds under the Equity-linked savings scheme (ELSS).
Securities transaction tax (STT) is charged on the sale of long term equity mutual funds. STT is a different tax than Income Tax which is levied on transactions in certain securities in the stock market.
Short term capital gain on equity mutual funds
When any investment in equity mutual funds is sold before one year it is classified under short term capital gain or loss.
It is taxed at the rate of 15% u/s 111A. Indexation is not available for short term Equity mutual funds. Securities transaction tax (STT) is charged on the sale of short term equity mutual funds.
Taxation of Income from Debt Mutual funds
Tax treatment of Debt mutual funds is different from any other investment.
Dividend income from Debt mutual funds
It was exempt in the hands of investors up to 31st March 2020. It is taxable with effect from 1st April 2020. Dividend income is taxable under other sources of income as per the slab rates.
Long term capital gain on Debt mutual funds
When any investment in debt mutual funds is sold after 3 years (36 months), it is classified under long term capital gain or loss. No STT is charged on the sale of long-term debt mutual funds.
Indexation benefit is available for long term Debt mutual funds. It is taxable at the rate of 20% after indexation u/s 112. Debt mutual funds are the only financial instrument on which indexation benefit is available. Indexation benefit reduces the tax outflow of debt funds considerably as compared to investments in fixed deposits and many other small savings schemes. Indexed cost can be calculated by multiplying the cost with the cost inflation index of selling and buying years.
Short term capital gain on Debt mutual funds
When any investment in debt mutual funds is sold before 3 years (36 months), it is classified under short term capital gain or loss. No STT is charged on the sale of short-term Debt mutual funds.
Indexation benefit is not available for short term Debt mutual funds. It is taxed as per the normal tax slab of the individual.
Summary of Dividend and Capital gain Tax on Mutual Fund Redemption
| Criteria | Equity Mutual Funds | Debt Mutual Funds |
|---|---|---|
| Dividend Income | Taxable at Applicable Rates | Taxable at Applicable Rates |
| Short term Capital Gains | 15% | Taxable at Applicable Rates |
| Long term Capital Gains | 10% (No Indexation allowed) Exempt up to Rs. 1 Lakhs | 20% (With Indexation Benefit) No Exemption |
| Holding Period for Long Term | 12 months | 36 months |
| Securities Transaction Tax (STT) | Charged on Redemption or Switch out. | Not applicable on Redemption or Switch out. |
Tax Deduction under Section 80C
Certain types of Equity mutual funds qualify for deduction under section 80C of Income-tax. These schemes are known as Equity-linked saving schemes (ELSS). Investments in these mutual funds qualify for deduction under Section 80C.
The maximum investment amount eligible for deduction is Rs 1.5 lakhs. Investors in the highest tax bracket of 30% can save up to Rs 46,350 in taxes (Rs 1.5 lakhs X 30.9% tax + cess) by investing in ELSS mutual funds.
Conclusion
Mutual funds are one of the most attractive investment options as they help us achieve our financial goals. Investing in fixed deposits is a great disadvantage. If you are under the highest income tax bracket, interest income from fixed deposits is added to your taxable income and taxed at your income tax slab rate.
Mutual funds score better here as they offer returns in the form of capital appreciation. Although dividend from mutual funds is taxable at applicable rates, still one can plan and invest in the growth schemes that offer capital appreciation. Expert money management and tax-efficient returns are the greatest advantages of investing in a mutual fund.
