Understanding Taxation in Mutual Funds


One of the most common ways investors use to increase their capital in both long and short terms is investing in various mutual funds existing in the market. While these funds yield a good margin of profit, they also come under the ambit of taxable income. This little caveat is what catches on.

vice investors unaware when they become over-ambitious in the field of mutual fund investment. Knowing about the important rules in taxation of mutual funds saves the investors from certain ruin as well as gives them an advantage compared to their peers.

Here are the salient features of tax rules which apply to the mutual funds.

  1. Debt Funds

On the debt funds, long-term capital gains, which is fixed as more than 3 years, are taxed at a uniform rate of 20% after indexation. This indexation is necessary as well as a useful process to factor out the rise in inflation between the years of the purchase of the funds and their sale. Contrary to the long-term debt funds, short-term debt fund gains are added to taxable income and then taxed under the income tax slabs applicable to the investor concerned.

  1. Non-Tax Saving Equity Funds

Short-Term Capital Gains on these equity funds are not exempted from taxation and are taxed at a rate of 15%. Long-term Capital Gains, however, are exempt from tax as long as gain is less than Rs. 1 lakh at the time of assessment. If the gain is more than Rs. 1 lakh, the return is taxed at a rate of 10% on the basis of the inflation at the time of purchase of the funds.

  1. Tax-Saving Equity Funds

Such equity funds are regarded as the most efficient way of saving taxes by the seasoned investors under Section 80C of the Income Tax Act, 1961. Since Equity-Linked mutual fund have a lockdown period of 3 years, they cannot be accessed by the investor and the assessor alike. After the termination of lockdown period, a maximum rate of 10% is levied as tax on the long-term capital gains as long as the gains are in excess of Rs. 1 Lakh. This tax, however, is levied without the benefit of indexation. Short-term capital gains and long-term capital gains up to Rs. 1 lakh are exempted from the tax assessment.

  1. Balanced Mutual Funds

Balanced type mutual funds are hybrid-type mutual funds which invest their majority of capital in equities. Hence, the tax assessment in this category is the same as that of non-tax saving equity funds.

  1. SIP

One of the most famous strategies of investing in mutual funds, Systemic Investment Plans (SIPs) are taxed on the basis of type of mutual fund and the holding period. For taxation purposes, each SIP is treated as a separate investment and hence is taxed differently. The basic point of taxation in SIPs is the duration of holding period – the longer the duration, the more tax-efficient the SIP becomes. One major relief, however, is that he returns earned from the first SIP is kept tax-free, while returns from other SIPs are considered taxable.

These are some of the salient points which will be useful for investors of present and future to calculate about the tax to be paid and net returns gained while investing in mutual funds. Investors would do well to heed these rules and guidelines while putting their capital in various mutual funds.