Taxes impact and affect your investments in several ways. Firstly, capital gains on mutual funds are subject to capital gains tax. Additionally, dividends might not be charged to investors, but dividend distribution tax (DDT) may be levied. Also, there are several tax-saving funds available to investors such as ELSS funds (equity-linked savings scheme), also known as tax saving mf that offers benefits up to Rs1.5 lakh u/s 80C. You can save up to Rs 46,800 by investing in ELSS mutual funds. This article is a quick guide for taxation on mutual fund investments.

Mutual funds are broadly divided into 2 types – equity funds and debt funds. Let’s understand how these funds are taxed.The period for which an investor stays invested is known as the holding period. A holding period plays a significant role in determining the tax implications on your mutual fund investments.

Types of holding period

Different types of mutual funds have varying criteria for what constitutes a long-term and short-term horizon.

  1. Long-term holding period – For equity funds, the investment is regardedto be long term if the duration is equal to or more than a year. In the case of debt funds, a holding period of 3 years or more is considered as long term.
  2. Short-term holding period – Equity mutual funds held for less than a year are considered as short-term. Debt mutual funds are considered short-term if the investment is held for less than 3 yeas.

Hybrid funds, having an equity exposure of 65% or more are taxed similar to equity mutual funds. If the equity exposure is equal to less than 65%, it is treated like a debt mutual fund for taxation.

Taxation on mutual funds

  1. Equity mutual funds–Short-term capital gains tax, also known as STCG in equity investments are taxed @15% + 4% cess. Long-term capital gains tax, also known as LTCG in equity funds is taxed @10% without the benefit of indexation*, given the capital gains in a particular financial year is over Rs 1 lac. LTG up to Rs 1 lac is entirely tax-free.
  2. Debt mutual funds – LTCG on debt mutual funds are taxable @20% with the benefit of indexation. STCG on debt funds are taxed according to the income tax slab of the investor.

*Indexation is a method of factoring inflation from the time of purchase of mutual fund units to its sale.It allows inflating the purchase price of debt funds to bring down the value of capital gains.

As an investor, it is vital to consider the tax implication on your investments as taxes have the potential to eat away a huge portion of your returns. So choose the right mutual fund for your portfolio by analysing your financial goals, investment horizon, risk appetite,  and tax implications. That being said, do not invest in mutual funds with the sole purpose of saving tax. Happy investing!