Taxation of Income from Mutual Fund

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Taxation of Income from Mutual Fund

Taxation law is part of dynamic law which never remains constant and so taxpayers have to keep updated for effective tax planning.

 With the drastic reduction in the interest rate of bank FDR, many taxpayers have switched to investment in mutual funds for getting higher returns. Furthermore, the booming share market has also lured many investors as other alternatives like real estate, Gold, etc. are not yielding desired results. It is also considered as one of the most buzzing investment options due to easy liquidity & capability to deliver higher returns. Income from mutual funds could be by way of dividends or capital appreciation (capital gain), which is also tax-friendly. With the due date of filing return approaching nearer, one needs to know about the rule applicable on taxation of mutual funds.

Taxation of Dividend from Mutual Funds:

Now, Dividends offered by any mutual fund are taxable like any other normal income of the taxpayer i.e., it is to be added to the overall income and taxed at their respective income tax slab rates. [Earlier, Payer of dividend was liable to pay Dividends distribution tax (DDT) & so the dividends received from domestic companies was tax free up to Rs 10 lakh a year in the hands of investors. Any dividends in excess of Rs 10 lakh attracted dividends tax at 10%].

Taxation of Surplus on Redemption/Transfer of Mutual Funds:

Calculating tax on investment could be a little tedious and laborious. The taxation of returns depends on the kind of funds in which the amount is invested i.e., whether investment is in debt schemes, equity schemes or hybrid schemes. Also, the duration of investments is relevant to determine whether the gain is short-term capital gain (STCG) or long-term capital gains (LTCG).

Holding period for Reckoning Long Term Vs. Short Term

Fund type Holding Period for STCG Holding Period for LTCG
Equity funds or Hybrid equity-oriented funds
Less than 12 months
12 months and more
Debt Fund or Hybrid debt-oriented funds
Less than 36 months
36 months and more

Kind of Investment:

  1. Debt schemes or Hybrid Debt oriented Fund:
    a) If invested in a debt fund for less than 3 years, returns are treated as STCG for taxation purposes. STCG is added to the income and taxed as regular income according to applicable income tax slab.
    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.
  2. Equity schemes (EOMF) or Hybrid Equity oriented fund:
    If a 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 funds for the purpose of taxation.
    a) If EOMF are sold within a year of its investment, returns would be treated as (STCG) & taxed at a special rate of 15% U/s 111A.
    b) If EOMF is sold after a year of its investment, returns would be treated as LTCG. Any LTCG arising on equity mutual funds shall be taxable @ 10% if it exceeds Rs. 1 Lakh in a year. No indexation benefit is available on such investment. If any investment is done prior to 01.04.2018 but sold afterwards then appreciation till 31.01.2018 will remain tax-exempt due to grandfathering clause and only appreciation in value after 31.01.2018 will be taxable. Further, the NAV as on 31.01.2018 can be accessed at the website of Association of Mutual Funds in India’s (Amfi) website by clicking at www.amfiindia.com/net-asset-value/nav-history
  3. Taxation of investment done through Systematic Investment Plan (SIP):
    Systematic Investment Plan (SIP) is the mode 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 the nature of mutual funds & according to the holding period, as already discussed above.
    In SIP, there are multiple dates of acquisitions as a 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.  An example illustrated below would make the understanding easy.

Suppose a person is investing Rs. 10,000/- every month by way of monthly SIP. After receipt of the amount, the Mutual fund will allot units to the investors based on its Net Assets Value (NAV). On the basis of illustrative NAV given below, the investment as well unit balance of the investor in mutual fund is illustrated as under:

SIP
Investment Date
Investment Amount
NAV
Units Allotted
Total Units
1st
01.06.2020
Rs. 10,000
Rs. 15
666
666
2nd
01.07.2020
Rs. 10,000
Rs. 14
714
1380
3rd
01.08.2020
Rs. 10,000
Rs. 17
588
1968
4th
01.09.2020
Rs. 10,000
Rs. 16
625
2593
5th
01.10.2020
Rs. 10,000
Rs. 15
666
3259

Only 5 investments of Rs. 10,000/- each are considered for the sake of illustration ignoring fractional units. Let us assume that investors want to withdraw Rs. 40,000/- from the SIP on 06.08.2021 at a prevailing NAV of Rs. 20/-. To withdraw the amount of Rs. 40,000/- @ Rs. 20/- per unit, he would be required to redeem 2000 units which means that all units purchased on 1st June, July, August (i.e., 1968 units) & 32 units from investment of 01.09.2020 would be redeemed. Since 1968 units are held for more than a one-year period, gain from 1968 units would be treated as LTCG. Gain from 32 units would yield STCG as the investment is held for a period of less than one year. Mutual Fund house also provides the profit/loss statement on above basis.

Above Taxation mode of the mutual fund is summarized in the chart as under:

Fund type Short-term capital gains Long-term capital gains
Equity funds or Hybrid equity-oriented funds
15% + cess + surcharge
Up to Rs 1 lakh a year is tax-exempt. Any gains above Rs 1 lakh are taxed at 10% + cess + surcharge
Debt Fund or Hybrid debt-oriented funds
Taxed at the investor’s income tax slab rate
20% + cess + surcharge

Frequent changes in the tax laws requires taxpayers to remain updated. Taxpayers should now remember that the dividend from a mutual fund is no more tax free and should incorporate it while filing the ITR.

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

 

 

 

Taxation of Income from Mutual Fund

 

Taxation of Income from Mutual Fund

 

Taxation of Income from Mutual Fund

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