Mutual funds are among the most popular investments as they can assist you in reaching your financial objectives. They are also tax-efficient. funds can also be tax efficient options. The investment in fixed deposit accounts is one of the biggest disadvantages, particularly when you are in the tax bracket with the highest amount because the interest will be added to your tax-paying income and is taxed according to your income tax slab. This is the reason why mutual funds are more successful. If you put your money into mutual funds you benefits of expert management of money along with tax-efficient return. Here all about Mutual Fund Taxation
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How Can You Earn Profits from Mutual Funds
Mutual funds provide investors the opportunity to earn returns in two ways such as capital gains and dividends. Dividends are derived from the company’s profits in the event that they occur. When companies are left with excess cash and surplus cash, they could decide to share this with investors through dividends. Investors are paid dividends in proportion to the amount of units from mutual funds owned by them.
Capital gains are the gain made by investors when the price at which they sell of the security owned by them is greater than their purchase price. In simple terms capital gains occur through the increase in the value of mutual unit of funds. Capital gains and dividends are tax deductible for the benefit of investors of mutual funds.
Income Taxes of Dividends Given to Mutual Funds
In accordance with the changes made within the Union Budget 2020, dividends provided through any mutual fund scheme will be taxed in the traditional manner. This means that dividends earned from investors will be taxed as income tax and taxed at the individual income tax slab rates.
Prior to the tax reform, dividends were tax free for investors because the companies pay dividend distribution taxes (DDT) prior to paying their dividends to investors through dividends. Under this system dividends (received from domestic corporations) that were up to 10 lakh per year were tax-free for the investors’ investors. Anything over 10 lakh in a year were subject to dividend distribution tax of 10 percent.
Income Tax on Capital Gains Presented through Mutual Funds
The tax rate for capital gains from mutual funds is contingent upon the duration of holding and the kind the mutual funds. The duration of the holding is the period of time during which mutual unit was owned for by the investor. In simpler terms the holding period is the time period between the date of purchase and the sale of mutual unit funds. Capital gains made from trading units from mutual funds are classified as fig.1. The capital gains provided by mutual funds are taxed at different rates.
Taxation of capital gains of equity Funds
Equity funds are the mutual funds that have a portfolio whose equity exposure is greater than the 65% mark. Like we said the fund will earn small-scale capital gains when you redeem the equity fund units within one year. The gains you earn are taxed on the flat percentage of 15% regardless of your tax bracket.
Capital gains that are long-term occur when you sell your equity fund units following the holding period is at least one year. Capital gains up to 1 lakh per year are tax exempt. Any capital gains over the limit will be subject to LTCG tax at a amount of 10 percent however there’s no advantage of indexation.
Fiscal Treatment of Capital Gains from Debt Funds
Debt funds are the mutual funds which have a debt-to-income ratio that is greater than 65percent. In the above table, you will receive short-term capital gains when you redeem those funds units over the three years. This gain is added on to tax-deductible income and are taxed according to your tax slab for income.
Capital gains over the long term are realized when you sell shares of a bond fund following a holding period that is three years. The capital gains will be taxed the percentage of 20% following indexation. Additionally, you will be charged the applicable cess and tax surcharge on tax.
The taxation on capital gains Hybrid Fund
The tax rate applicable to capital gains from balance or hybrid funds is contingent to the proportion of equity that the fund has. When the equity portion is greater than 65 percent, then the fund scheme will be taxed as an equity fund however, if it does not, the taxation rules applicable to the debt funds apply.
So, it is crucial to understand how much equity is involved in the hybrid plan that you are investing in, and if you don’t you could be in for a gruesome shock when you redeem your unit of funds. The fig.2 table provides the percentage of capital gains taxation for mutual funds:
The taxation on capital gains invested through SIPs
Systemsatic Investment Plans (SIPs) can be described as a way for investing into mutual funds. The plans are created in that investors are able to invest a tiny amount regularly in an investment scheme for mutual funds. Investors have the freedom to pick the time that they invest. It could be monthly, weekly or quarterly, bi-annually or even annually.
You purchase a set amount of unit units for mutual funds in each SIP installment. They are then redeemed. is done in a first-in-first-out manner. If you decide to invest with an equity funds using an SIP for a period of one year and you decide to cash out your entire investment within 13 months.
In this scenario the first units you purchase by way of the SIP are kept for the duration of the contract (over 1 years) and you earn capital gains over the long term on the units. If the capital gains over the long-term are lower than the threshold of 1 lakh rupees, you do not have to pay tax.
But, you can make small-scale capital gains on units that you buy through SIPs starting from the second month. They are taxed as the flat amount of 15 percent regardless of your income tax bracket. You’ll be required to pay the appropriate taxes and surcharges on it.
Securities Transaction Tax (STT)
Other than the tax that is imposed on capital gains and dividends In addition, there is a tax, known as taxation of the Securities Transaction Tax (STT). A tax of 0.001 percent is imposed through the state (Ministry of Finance) when you choose to purchase the units from the equity funds or hedge fund with a hybrid approach to equity. The government does not impose an STT for selling debt funds. The longer you keep your mutual fund units the more tax efficient they are. Taxation on long-term capital gains is generally lower than the tax for short-term gains.