Taxation of Income from Mutual Fund: Old Regime Vs. New Regime

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Dividend Distribution Tax (DDT) has been finally abolished by the Finance Act – 2020 which means that the payer (may be a company or mutual funds) will not be required to pay the DDT on payment of Dividend. Earlier, payer was required to pay the DDT & the Dividend was exempt in the hands of the recipient. Now, after abolition of the DDT, the recipient will be liable to include the dividend in his income and will be subject to tax according to the applicable tax slab & rate. Let us revisit the provision related to income from mutual fund after all recent changes.

Income from mutual fund could be income by way of

  1. Dividend or
  2. Appreciation in the value of the funds which could arise at the time of redemption or transfer.

Before elaborating about the taxation of Dividend, let us first know about the taxation of appreciation in the value of mutual funds.

Taxation of appreciation in the value of Mutual Funds:

Taxation of appreciation in the value of mutual funds is always tricky to some extent. Its taxation differs depending upon the,

  1. Nature of funds in which investment is done (i.e., .whether investment is in debt scheme or equity schemes)
  2. Period of investments (i.e., it is relevant to determine whether the gain is short-term capital gain (STCG) or long-term capital gains (LTCG)].

 

Kind of Investment:

  1. Debt schemes
  2. a)If invested in a debt fund for less than 3 years, returns are treated as STCG for taxation purpose. STCG are added to the income and taxable as regular income i.e., according to applicable income tax slab.
  3. b)If investment in a debt fund is for a period of more than three years, returns would be considered as LTCG. It will be taxable @ 20% with indexation benefit.
  1. Equity schemes (EOMF):
    If  mutual fund scheme invests more than 65% of its fund in equity then such mutual fund scheme qualifies as equity oriented mutual fund (EOMF) or equity scheme for the purpose of taxation. Arbitrage funds are treated as equity schemes for the purpose of taxation whereas International fund stocks abroad & Fund of funds are also treated as debt fund for the purpose of taxation.
    a) If EOMF are sold within one year of its investment, returns would be treated as STCG & taxable at a special rate of 15% U/s 111A.
    b) If EOMF is sold after one year of its investment, returns would be treated as LTCG. Earlier, LTCG on Equity Mutual Fund was exempt from tax. But, after amendment by the Finance Act -2018, it has been made taxable @ 10% if the capital gain amount exceeds Rs. 1 Lakh in a year. No indexation benefit is available on such investment as concessional rate of taxation of just 10% is provided for this.  It may be noted that even all investment done prior to 01.04.2018 but sold afterwards will also be taxable now. However, appreciation till 31.01.2018 has been grandfathered, i.e., gains will remain tax-exempt & appreciation in the value after 31.01.2018 will be taxable.
  2. Taxation of investment done through Systematic Investment Plan (SIP):
    Systematic Investment Plan (SIP) is the method of investing a fixed amount in a mutual fund in a periodic manner (may be weekly, fortnightly, monthly, quarterly or yearly). Gains arising from SIPs are taxed according to nature of mutual fund & according to the holding period, as already discussed above. In SIP, there are multiple dates of acquisitions as fixed amount is invested at regular occasion. For the purpose of taxation, each individual SIP is treated as a separate & fresh investment & gain on it is required to be computed separately. For calculating gain, FIFO (First in- First Out) Rule is followed and capital gain has to be computed with reference to units sold vis a vis its acquisition. Based on the number of units sold, one needs to determine the equivalent number of units purchased with corresponding date & purchase price. It is possible that the number of units sold can belong to different dates. Units purchased, date wise and cost wise, need to be allocated to the units sold on “FIFO” basis to arrive at the amount of capital gain amount.

Readers may refer the chart summarizing the taxation of appreciation in the value of mutual funds as under:

Holding Period/ Types of Funds Less than One Year 1 to 3 Years More than 3 Years
 

Equity & Hybrid Mutual Funs

15% Tax plus surcharge as applicable 10% tax on gains exceeding Rs. 1 Lakh plus Cess & surcharge as applicable 10% tax applicable if gains are more than Rs. 1 Lakh plus Cess & surcharge as applicable
Debt Mutual Fund Taxed as per Income Tax Slab plus Cess & surcharge as applicable Taxed as per Income Tax Slab plus Cess & surcharge as applicable 20% Tax plus Cess & surcharge as applicable tax applicable with indexation benefits

 

Taxation of Dividend:

–         After the abolition of the DDT, the recipient will be liable to include the dividend as “Income from Other Source” and will be taxable like other regular income. It may be noted that there is no exemption or basic threshold exemption as was available earlier (like section 80L deduction). All dividend paid above Rs. 5,000 in a financial year will attract tax deduction at source (TDS) as well.

–         Common question now raised by few investor is, what they should do from tax planning perspective. I would suggest that;
a) Those investors whose income is not subject to tax or income is below the basic exemption limit, they may continue to remain in the dividend payout options as they would be benefitted more by the abolition of the DDT.
b) Those taxpayers who are in higher tax slab, it is advisable to shift their fund from Dividend Payout option to the Growth options as tax rate is still concessional in case of mutual fund investment with growth option.

–         Those taxpayers who were opting for dividend payout options earlier for the reasons that they were requiring monthly income may opt for Systematic Withdrawal Plan (SWP). SWP is better than dividend payout plan for the simple reason that investors can still save some tax through it.

[Readers may forward their feedback & queries at nareshjakhotia@gmail.comOther articles & response to queries are available at www.theTAXtalk.com]

 

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