Mutual Funds are one of the most popular investment options in India which has the potential to offer capital gains. With many online wealth management platforms such as myMoneySage, mutual fund investing has become easier and seamless. However, before you start investing in mutual funds or allocate your mutual fund holdings against a financial goal, you should understand about the tax of mutual funds.
Before we talk about how mutual fund investments are taxed, let us understand an important term called Holding Period, which is crucial to determine the tax implications on your mutual fund investments.
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Holding Period in Mutual Funds
In mutual funds, the holding period is the time for which you owned a unit of the mutual fund scheme.
For example, assume that you bought 5 units of a fund on 1st April 2019, and again bought 10 units of the same scheme on 1st August 2019. If you sold all the 15 units on 1st April 2020, then the holding period of those 5 units is determined as 12 months, and the remaining 10 units are determined as 8 months.
From a tax point of view, the holding period is categorized as long-term holding period and short-term holding period.
Long-term Holding Period
For equity funds and hybrid funds that have more than 65% exposure to equity, a holding period of 12 months or more is considered long-term.
For debt funds, dynamic asset allocation funds, and hybrid funds that have less than 65% exposure to equity, a holding period of 36 months or more is considered long-term.
Short-term Holding Period
For equity funds and hybrid funds having more than 65% exposure to equity, a holding period of less than 12 months is considered short-term.
For debt funds, dynamic asset allocation funds, and hybrid funds that have less than 65% exposure to equity, a holding period of less than 36 months is considered short-term.
Taxation on Mutual Funds
The tax rate applicable for mutual funds depends on how that type of fund is categorized for taxation purposes. Let us understand the tax applicable for each type of mutual fund.
In case of capital gains made over long-term, a rate of 10% is applicable provided the capital gains exceed Rs.1 lakh in a year, and there is no benefit of indexation. This is known as the Long-term Capital Gains Tax (LTCG Tax).
In the case of gains made in the short-term, a rate of 15% applies to the gains made. For ELSS, Short-term Capital Gains (STCG) tax is not applicable as it comes with a lock-in period of 3 years.
For debt funds, an LTCG tax rate of 20% is applicable after indexation if you have sold your units after holding it for 3 years or more.
In case you held your debt fund units for less than 3 years, STCG tax is applicable. However, there is no fixed tax rate for STCG of debt mutual funds. Instead, the short-term capital gains are added to your income, and income tax is payable at the applicable tax slab rate.
Hybrid Funds that are classified as equity-oriented i.e. have more than 65% exposure to equity are taxed in the same manner as that of equity mutual funds for both short-term and long-term.
Hybrid Funds which have less than 65% exposure to equity are considered as debt funds for taxation purpose and the tax laws of debt funds are applied.
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How are SIPs taxed?
SIPs(Systematic Investment Plans) are a method of investing in mutual funds. The taxation on a mutual fund is done on a pro-rata basis. Each SIP is treated as a new investment, and the holding period is determined as short-term or long-term depending on the holding period.
The tax rates applicable are decided according to the type of scheme you are investing in through SIP.
For example, if you initiate a SIP of Rs 5000 a month in an equity fund for 12 months, then each SIP is considered as a new investment. If you redeem your investment along with the gains at the end of 12 months, your entire gains will not be tax-free. The gains you made on the first SIP would be tax-free as only that would have completed 12 months. The rest of the gains would be subject to short-term capital gains tax.
Securities Transaction Tax
This tax is levied by the Government when you sell units of an equity fund or any fund which is considered as an equity fund for tax purposes. There is no STT on the sale of debt fund units.