What are the tax benefits of investing in mutual funds?
Will I be getting any kind of tax rebate or deduction on my income from mutual fund investing?
These types of questions may crop up if you are about to start your investment journey. Well, in this article, we have explained the tax implications on mutual funds investment in detail.
It’s always better to know the tax implications before investing in any financial assets including mutual funds. Your personal income tax liability will be calculated based on the asset classes in which the mutual fund scheme has invested.
How to calculate income tax on mutual fund investments
In order to understand the tax benefits better, you have to categorise mutual fund scheme into following two main types;
- equity-oriented mutual fund schemes
- non-equity-oriented mutual fund schemes
- Specified mutual funds
- Other non-specified mutual funds
If a mutual fund scheme invests at least 65% and above of their net assets in equity shares of listed indian companies, then that scheme will be considered as equity oriented mutual fund scheme.
This means, if a scheme’s net asset investment is less than 65% in equity shares listed in indian stock exchanges, then those schemes will be considered as non-equity oriented mutual fund schemes.
Infrastructure debt funds, liquid funds, debt funds, gold funds are considered as non-equity schemes as they invest less than 65% of their net assets in listed indian companies.
Non-equity oriented mutual fund schemes are further classified into two types as per tax laws. We will be discussing it in a later part of our article.
Capital gain tax on mutual funds investment
Any gain from the sale of mutual funds is taxed in India based on the income tax rates applicable to you.
Type of capital gain and tax rates are determined based on the period of holding and the type of the mutual fund.
If the period of holding is less than 1 year in the case of equity schemes, gain arising from sale of these units will be considered as short term capital gain.
In the case of non-equity schemes the period of holding is 3 years.
Which means, gain arising from a non-equity scheme will be considered as short term capital gain if the period of holding is less than 3 years.
Now what if the period of holding is more than 1 year for equity schemes and more than 3 years for non equity schemes. In this case, it will be considered as long term capital gain.
In the case of short term capital gain the tax rate is 15%.
Long term capital gains are taxed at the rate of 10% over 1,00,000 rupees.
Long term capital gains up to Rs 1 Lakh is totally tax free.
This means, if an equity fund is redeemed within a period of 1 year, then gains from such a fund are taxed at the rate of 15% irrespective of the amount of gain. If the same is redeemed after a period of 1 year, the gains over 1,00,000 rupees will be taxed at the rate of 10%.
Capital gain tax on specified mutual funds
Specified mutual fund means, the exposure in equity shares of domestic companies is up to 35%.
If the mutual fund’s exposure to equity shares in domestic companies is between 35% to 65%, then it will be considered as other non-equity mutual funds.
The Specific mutual fund concept is newly introduced in the income tax act. As per this change, if the specified mutual fund is purchased on or after 1/04/2023, then capital gain on sale of these funds is considered as short term capital gains irrespective of the period of holding. Which means, it will be added to the investor’s taxable income as short term capital gain irrespective of the holding period.
If specified mutual funds are purchased before 1/04/2023, then old provisions as it was applicable to non-equity mutual funds will be applicable. In this case, if the units are held up for 3 years or less, it will be considered as a short term capital gain. If the period of holding is more than 3 years, then it will be treated as long term capital gain, which is taxed at the rate of 20% with the benefit of indexation.
Capital gain tax on other non-equity mutual funds
In the case of other non-specified non-equity mutual funds, if the redemption is within 3 years, then the gain will get added to your income and will be taxable based on the income tax slab applicable to you.
If other non-specified non-equity mutual funds are redeemed after a period of 3 years, then the gain arising from such sale will be taxed at the rate of 20% with an indexation benefit.
Indexation is an adjustment to the purchase price of a particular value for inflation. This adjustment due to inflation is calculated every financial year, and the value is known as the Cost Inflation Index (CII). The main purpose of using CII is to factor in the rise of prices so that investors have to pay tax only on the “real gains”.
Income tax deduction on mutual fund investments
If you have opted for the old tax regime to pay your taxes, then you can claim tax deduction under section 80C of the Income tax act, 1961, up to Rs 1.5 Lakh a year on investments made in ELSS (Equity-Linked Savings scheme) mutual fund.
Equity Linked Savings Scheme (ELSS) is an equity diversified fund which is linked to the equity market. ELSS is a mutual fund scheme that invests your money into equity and equity-related securities.
You will not be eligible for section 80C tax deductions if you have opted to pay income tax as per the new tax regime under section 115BAC.
How dividend income from mutual funds are taxed
Dividends received from mutual funds are taxed based on the income tax slab and rates applicable to you. Dividends get added to your total income under the head “income from other sources” to get taxed at the rates applicable to you.
You need to check your AIS and form 26AS before filing your income tax return as in most of the cases taxpayers are not aware of the total dividend that they have received for the whole year.
AIS is available in the income tax portal and will show you the entire dividend income received for the whole financial year. If any dividend received by you is not reflecting in the AIS, then add it to your income to calculate exact tax liability.
Please note, if the dividend received is in excess of 5,000 rupees, then under section 194K tax will be deducted (TDS) at the rate of 10% on your dividend income.
You can avoid deduction of tax at source (TDS) on dividend income by filing form 15G/15H if your income is below the basic exemption limit or you are not taxable.
Taxation of Mutual Funds
| Fund Type | Holding Period | STCG | LTCG |
| Equity-oriented funds which invests at least 65% in equity | 12 months | 15% | 10% without indexation |
| Specified mutual funds which invest 35% or less in equity, debt fund, floater funds and conservative hybrid funds if purchased on or after 01/04/2023 | 36 months | Slab rate | Not applicable as all gains will be considered as short-term irrespective of the holding period. Therefore, it will be taxable as per the slab rate applicable. |
| Specified mutual funds which invest 35% or less in equity, debt fund, floater funds and conservative hybrid funds if purchased before 01/04/2023 | 36 months | Slab rate | 20% with indexation |
| Other mutual funds which invest more than 35% but less than 65% in equity | 36 months | Slab rate | 20% with indexation |
Frequently Asked Questions on Mutual fund – FAQs
Should I pay taxes on mutual fund investments every year?
Capital gain will be charged to tax only when you sell your mutual fund investments. Otherwise, capital gain tax will not be applicable. If you are receiving a dividend on mutual fund investments every year, then it will be charged to tax.
How to avoid capital gain tax on mutual funds?
Tax on capital gain arising by selling mutual funds can not be avoided. You have to pay taxes in India as per applicable rates.
Can I claim a rebate on income tax by investing in mutual funds?
If you have opted to pay taxes as per the old tax regime, then you can claim tax deduction under section 80C of the Income tax act, 1961, in case of investments in Equity linked saving schemes (ELSS). Your tax deduction can be up to Rs 1,50,000.
In case you have selected to pay taxes as per new tax regime under section 115BAC, then section 80C tax deduction is not applicable.
Can I avoid TDS on dividend income from my mutual fund investments?
Yes, you can avoid it if your taxable income is below the basic exemption limit or you are not taxable for the whole year.
In order to avoid TDS on dividend income from your mutual fund investments, you need to submit form 15G. If your age is 60 years or above, then instead of 15G, you need to submit form 15H.
You can also try investing in a growth fund to avoid dividend income to your taxable income.
Related article: How to avoid tax deduction on dividend income from mutual funds
