Mutual Funds cater to almost all the investments needs of investors be it debt, equity or gold. As the products offered by mutual funds differ, so does the tax treatment of different mutual fund products. These different products are taxed differently in India. The taxation is based on the kind of funds you invest, whether debt or equity schemes. The duration will decide whether the investment attracts short-term or long-term capital gains. Let us discuss.
Categorisation of mutual fund products for taxation
All the mutual fund products are divided in two different categories for taxation purposes. Under the first category, all the equity oriented funds are covered. And the residue schemes are clubbed under the second category which includes gold funds, debts funds as well as international funds. The second category is vast and includes liquid funds, short-term bond funds, debt funds, G-Sec funds, Fixed Maturity Plans (FMPs) gold ETFs, gold saving funds, fund of funds and international funds.
Let's look into equity oriented funds. Any mutual fund which invests at least 65% of its funds in Indian listed companies are classified as equity oriented schemes. This category includes any scheme which invests minimum of 90% of its funds in another exchange traded fund which in turn invests minimum of 90% of its funds in Indian listed companies.
Any mutual fund scheme which does not fall in the above category falls in second category by default. The units of the first category of scheme become long-term if held for more than one year whereas the units of any scheme falling in the second category are required to be held for more than 36 months for qualifying as long term. For investments made through Systematic Investment Plan (SIP), each SIP investment is treated as separate investment and the holding period is computed with reference to each SIP.
Taxation of dividends and profits on sale
Dividends from all mutual fund schemes are fully exempt for unit holders, but the fund houses have to pay tax in respect of the amounts distributed out of income to the unit holders. So, effectively the dividends are taxed at a uniform rate for all the investors whether one falls in the tax net or not and irrespective of the slab rate applicable to him.
Any profit realised on redemption/sale of mutual fund schemes are taxed under the head capital gains. For equity oriented schemes, the tax rate applicable is 15% if sold before 12 months.
In case of long-term capital gains for first category, the same are taxed at a flat rate of 10% without any benefit for indexation. However, the long-term capital gains on listed equity shares and equity oriented schemes is tax free up to initial Rs 1 lakh and the balance is taxed at 10%. These rates for equity oriented schemes will apply if the Securities Transactions Tax (STT) has been paid on redemption/sale of such units. For arriving at the cost of acquisition of equity oriented schemes, the NAV or market value as on 31st January 2018 has to be taken as cost.
On the other hand, the profits on redemption/sale of second category are taxed differently. Any short-term capital gain is treated like your regular income and gets clubbed with other income and gets taxed at the applicable slab rate. Long-term capital gains in this category are taxed at a flat rate of 20% after applying cost inflation index.
You can avail exemption from payment of tax on long-term capital gains for both the categories of schemes provided you invest the amount of net sale consideration received for buying or constructing a residential house subject to fulfilment of some conditions under Section 54F.
Taxation in case the other total income falls short of basic exemption and availability of deductions under Chapter VIA
In case you are a resident individual tax payer whose other income is lower than the basic exemption limit, the long-term capital gains of both the categories are to be reduced by the amount of such shortfall in basic exemption.
The same benefit is available in respect of short- term capital gains on units of equity oriented schemes to resident individual taxpayer.
Similarly, you cannot claim any deduction under chapter VIA, which covers section 80 C, 80CCD and 80D against the taxable long-term capital gains as well as short-term capital gains on equity schemes.
The rebate under Section 87A available upto Rs 12,500 to a resident individual can be claimed against the tax payable for all the category of capital gains except the long-term capital gains on equity oriented schemes. (The writer is a tax and investment expert and can be reached on firstname.lastname@example.org and @jainbalwant on his twitter handle)