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How are Mutual Funds Taxed?

When you earn, you have to pay taxes. However, you may be able to minimize your tax liability. The profits made through investments in various schemes offered by the asset management companies (AMCs) are also liable to taxes.

These earnings are classified as capital gains and you need to pay the capital gains tax on these. The tax liability on various schemes depends on the type of the fund and the tenure for which you hold your investments.

Holding period

The holding period for different types of mutual fund (MF) schemes varies. It may be either short-term or long-term. To make your investment in MFs tax efficient, it is recommended you stay invested for a longer period.

If you hold debt funds, long-term is defined as three years or more. The long-term for equity and balanced funds is defined as a period exceeding one year. When you exit your investment from debt funds before three years, it is termed as short-term. Similarly, investments held for less than one year for equity and balanced funds are known as short-term.

The following table shows the classification of the short- and long-term periods for different types of MFs.

Type of fund Short-term Long-term
Debt Less than 36 months 36 months or longer
Equity Less than 12 months 12 months or longer
Balanced Less than 12 months 12 months or longer

Taxation on mutual fund investments

Profits earned on your mutual funds are liable to taxes. Depending on your investment tenure, you may either pay Short-term Capital Gains Tax (SCGT) or Long-term Capital Gains Tax (LCGT).

  1. Debt funds

The gains on investments made in debt funds for a period exceeding 36 months i.e. three years are taxable under LCGT. The applicable rate is 20% after taking advantage of the indexation benefit.

Indexation is a technique that allows you to account for the rate of inflation during the period between the date of your investment and the exit date. Indexation enables you to reduce the actual gains made on your investments. Therefore, your tax liability is reduced when you avail of the indexation benefit. To know more on how to save tax with mutual funds through indexation, you may search on the Internet.

If you retain your debt fund investments for a period below three years, your profits are subject to SCGT. This is payable according to your income tax slab.

  1. Equity funds

All profits made for equity fund investments held for a period exceeding 12 months are deemed as long-term capital gains and are tax-free. However, if you exit your investments prior to 12 months, the profits are liable to SCGT at 15%.

Equity-Linked Savings Scheme (ELSS) is one of the best tax-saving schemes and is tax-free. ELSS is an exempt-exempt-exempt (EEE) scheme. It means your investments, profits, and maturity incomes are all tax-free.

  1. Balanced funds

AMCs invest at least 65% of the balanced fund corpus in equity and related products. Therefore, these are types of hybrid equity funds. The taxation on balanced funds is thus the same as equity funds.

You pay no LCGT when you hold your investments in balanced funds for 12 months or longer. SCGT, when you exit before 12 months, is 15%.

Let us tabulate the tax implications on different types of funds.

Type of fund Short-term capital gains tax Long-term capital gains tax
Debt funds As per your income tax rate 20% post indexation
Equity funds 15% Tax-free
Balanced funds 15% Tax-free

Taxation on Systematic Investment Plans (SIPs)

When you invest in regular schemes or tax-saving schemes through an SIP, a fixed amount is invested on a pre-determined date. Profits earned on SIPs are also considered as capital gains and tax liability depends on your investment tenure and type of scheme.

To determine the tax liability, each SIP installment is considered as a fresh investment. The holding period to classify short-term and long-term is separate for each SIP investment.

Here is an example to understand the taxation on SIPs.

Assume you invest INR 5,000 on the first of each month for a period of one year in an equity fund. At the end of one year, if you redeem all your accumulated units, the tax liability is not the same for each installment. Only the profits earned on your first installment are tax-free because the holding period is 12 months. All other profits are taxable and subject to the 15% short-term capital gains tax rate.

It is important to know how to save tax with mutual fund investments to reduce your liability. However, it is equally crucial to choose the right funds to invest your hard-earned money.

Angel Wealth is here to help you with the same. Angel Wealth’s mobile application has ARQ, a technology-driven investment engine that offers machine-based recommendations about which funds are promising without any human intervention. Download the Angel Wealth mobile app today and get customized investment recommendations through the ARQ investment engine.

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