The mutual fund industry's asset base rose to a record high of Rs 14.4 lakh crore in April-June quarter, helped by strong participation from retail investors. Systematic investment plans, which offer the facility of investing a certain amount at a regular interval, have emerged as a popular investment vehicle for retail investors. Investments in mutual funds can be optimised by having proper understanding of tax implication.
- Tax on long-term capital gain in equity funds is zero
- Dividend income from equity funds are tax free
- Long-term capital gain tax on debt funds is at 20%
How Income From Equity Mutual Funds Are Taxed? For tax purposes, any mutual fund that invests 65 per cent or more of its portfolio in equities or equity-related instruments, are considered equity funds. If you redeem or withdraw your investments in equity mutual funds after 12 months, your investments would be considered as long term. Currently, the tax on long-term capital gain is zero. But if you sell or redeem your equity mutual fund investments before 12 months, you will have to pay short-term capital gains tax at a flat rate of 15 per cent.
Many investors opt for dividend option while investing in equity mutual funds. Dividend income from equity mutual funds is tax-free. For tax purposes, equity diversified funds, arbitrage funds and equity income funds are considered equity funds. Arbitrage funds invest in equity and derivatives such as futures and options while equity income funds invest in a mix of equity, equity derivatives and debt.
How Income From Debt Mutual Funds Are Taxed? Investments in debt funds are considered long term only if they are held for more than three years. Currently, the long-term capital gain on debt funds is taxed at the rate of 20 per cent. However, investors get the benefit of indexation on their original investment. This means that the original investment is adjusted for the price of inflation and taxed accordingly. Since the original cost of investment goes up after factoring in inflation, long term capital gains tax comes to negligible levels.
But if debt mutual fund investments are redeemed or sold before three years, the short-term gains are taxed according to your tax slab.
Income from debt funds also come in the form of dividends. Any dividend declared by a debt mutual fund is exempt from tax in the hands of investors. However, mutual fund houses pay dividend distribution tax from the distributable income at the rate of 28.33 per cent (including surcharge and cess).
How Systematic Withdrawal Plans Are Taxed? Systematic withdrawal plans are in a way reverse SIPs. Through systematic withdrawal plans (SWP) investors can redeem fixed units at regular intervals and the amount gets credited to their bank accounts. Under SWP, units are redeemed on FIFO basis (first in first out). This means for tax purpose it is assumed that units that are brought first are redeemed first.
The tax treatment in case of systematic withdrawal plans is the same as redemption/withdrawal from equity and debt funds.
In case of debt funds, financial planners suggest investors should chose the systematic withdrawal plan option instead of dividend option in case they want a regular income.
They say that investor should invest in growth option of debt funds and after three years, they should start withdrawing money. Such withdrawals will be treated as long-term capital gain and the tax impact would be minimal after factoring in the indexation benefits.
Though dividend is not taxed on the hands of investors, mutual funds pay 28 per cent tax on the distributable income. Thus the effective dividend in the hands investors is reduced due to this tax. By opting for systematic withdrawal plan, the investor can bring down the tax liability.