How Are Mutual Funds Taxed? Are Equity Funds Tax-Free?

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Every investor must be aware of the tax deductions applicable on the returns that they might earn on their investments. Therefore, we have come up with this blog to clarify about the same in a simple way. But first, let’s read what capital gain tax is.

What Is Capital Gain Tax?

Capital gain is the gain received by an investor on the capital invested, i.e., the amount received on maturity in excess of the purchasing price. Tax is the amount charged by the government to fund the public expenditures. Capital gain tax is a tax which is levied on the gains received at the time of sale.

What Are the Implications of Capital Gain Tax?

The returns received on mutual funds can either be short term capital gains or long-term capital gains. As there are different categories of funds such as equity and debt in mutual fund, the long-term and short-term period for both are different. Below table showcases both the tax rates and the time-period of these funds that are considered as short and long.

Capital Gain Tax Implications on Equity Funds

Below are the points explaining what LTCG and STCG in equity funds (65% or more investment in equities) are and the tax rates that are applicable on them.

Short-Term Capital Gain (STCG)

If an investor invests for a period of less than one year, then the gains earned on it will be considered as a short-term capital gain. 15% of this gain will be calculated as the STCG tax.

Long-Term Capital Gain (LTCG)

If an investor invests for a period of one year or more than one year, then the gains earned on it will be considered as a long-term capital gain and will be taxed accordingly.

Although earlier these gains used to be tax free but in the budget 2018, it has been stated by the financial minister that the same will now be taxable. With the applicability of the grandfather clause, all the investors who earned capital gain before 31st January, 2018 through the sale of equity mutual funds will be exempt from paying any LTCG tax. Any gains received beyond Rs. 1,00,000 through sale of mutual funds after this date including ELSS funds will be charged with 10% as LTCG tax.

Below is an example to explain it all to you in a better way:

Let’s say, an investor invested Rs. 3,00,000 in an equity scheme on 1st July 2016. How will the tax be calculated in the following cases?

1. If he redeems a total amount of Rs. 3,15,000 as on 15th June 2017.
2. If he redeems a total amount of Rs. 315,000 as on 15th July 2017.
3. If he redeems a total amount of Rs. 420,000 as on 15th July 2018.

Calculations:

1. In this case, since the time period of investment is below one year, it will be treated as STCG and the tax will be charged accordingly.
STCG = 15% * (315,000-300,000) = Rs. 15,000
= Rs. 2,250
2. Here, as the time period of investment is above one year, it will be treated as LTCG.
LTCG = (315,000-300,000) = Rs. 15,000
In this case, as the amount of gain is just Rs. 15,000 which is below Rs. 100,000 and the date is before 31st January, 2018, therefore no tax will be levied.
3. In this case, since the time period of investment is again above one year, it will be treated as LTCG and the tax will be charged accordingly.
LTCG = (420,000-300,000) = Rs. 120,000
In the above case, the amount gained is Rs. 120,000 which is above Rs. 1 lac. Therefore, 10% will be charged on Rs. 20,000 (1,20,000 - 1,00,000) amounting to Rs. 2,000.

Capital Gain Tax Implications on Debt Funds

Below are the points explaining what LTCG and STCG in debt mutual funds are and the tax which is applicable on them.

Short-Term Capital Gain (STCG)

If an investor invests for a period of less than three years, then the gains earned on it will be considered as a short-term capital gain. Under this, these gains will be added to the investor’s income and the tax will be charged according to tax slab bracket in which it falls.

Long-Term Capital Gain (LTCG)

If an investor invests for a period of three years or more than three years, then the gains earned on it will be considered as a long-term capital gain and taxed 20% with indexation.

Below is an example to explain it all to you in a better way:

Let’s say an investor invested Rs. 1,00,000 in a debt mutual fund on 1st May 2014. How will the tax be calculated in the following cases?

1. If he redeems Rs. 180,000 as on 3rd July 2016.
2. If he redeems a total amount of Rs. 220,000 as on 15th August 2017. Cost Inflation index for FY 2017-18 being 1172.

Calculations:

(i) Capital gain worth (180,000 – 100000) = Rs 80,000 is a short-term capital gain because holding period of investment is less than 3-years, therefore it will be taxed as per individual investor’s income tax slab.
(ii) In this case, the investment is held for more than 3 years, therefore it is subject to long-term capital gain.

LTCG = Sale value – Indexed cost of asset
= Rs. 220,000 – (100,000*1172/939)
= Rs. 220,000 – Rs. 124,813.6
= Rs. 95,186.4
Tax = 20% * 95,186.4
= Rs. 19,037.3

Implication of Dividend Distribution Tax

Dividend distribution tax is a tax which is levied on the dividend that is distributed to the investors. This tax is usually paid by the asset management company itself. Therefore, the investor is free from any such tax and the dividend received by them is tax-free.

Conclusion

Hope, you now understand that the capital gains received on both equity and debt funds are not tax free. However, the dividend received is tax-free. Even though, the capital gains are taxable, still the returns provided by them are higher compared to the traditional investment options. Thus, making them an investor’s favorite investment instrument. You may invest in mutual funds through our platform, MySIPonline and consult the experts, in case you need any assistance.

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Must Read: To get a better idea about LTCG and STCG taxation, you can watch the video given below.