Mutual funds are the good way to earn with little effort. This earning is also subject to tax like any other income. However, the tax rate for the mutual fund earning is lower. The rules of mutual fund taxation also differ according to the types of mutual fund. In this post, I would tell you the tax rules for each type of mutual fund.
The Basis For Tax on Mutual funds
There is no escaping of tax if you are earning from any source, be it a mutual fund or salary. However, you can minimize it and enjoy some relaxation. Such as equity mutual funds are not as much taxing as the debt mutual fund. The tax rate of the mutual fund is decided on the following basis.
- Type of Mutual Fund
- Holding Period of Mutual Fund
The mutual funds primarily invest in shares and bonds. On the basis of the allocation of shares and bonds, the funds are termed as equity mutual fund or debt mutual fund.
The tax rate of the mutual fund goes down if you hold it for a longer period. The rate is higher for the shorter period. On the basis of holding period, the profit of mutual fund is called as Long Term Capital Gains and short-term capital gains. The duration of Long Term and short term is different for equity and debt mutual funds.
Tax on Equity Mutual Fund
The mutual fund schemes which allocate at least 65% of the amount to shares are called as the equity mutual funds. When you sell an equity mutual fund scheme within a year, the profit from this transaction would be called as Short Term Capital Gains. So the ‘long-term’ for equity mutual fund starts after one year.
The tax rate of short-term capital gains of equity mutual fund is 15%. Thus, you have to pay 15% tax if you sell equity mutual fund within a year. Your income tax slab does not affect this rate.
The tax rate for Long Term Capital Gains of Equity mutual fund is 10%. However, there is no long-term capital gains tax up to the gain of ₹1 lakh. The tax is levied on the income which exceeds ₹1 lakh. Earlier, there was no Long Term Capital Gains tax on equity. It is introduced in Budget 2018.
You can learn more about the Long Term Capital Gains tax on shares and equity mutual funds.
Debt Mutual Fund Taxation
The mutual fund schemes which invest at least 65% of the amount into the bonds are termed as the debt mutual funds. However, the ‘Long Term’ for these funds comes little later. The holding period of at least 36 months (3 years) is the ‘Long Term’ for debt mutual funds.
Thus any profit arising within 36 months of the debt fund purchase would be Short Term Capital Gains. If you sell the debt fund after 3 year, the profit would be the Long Term Capital Gains.
There is no specific tax rate for short term capital gains of debt mutual fund. Rather, the profit is added to your taxable income. Hence the tax rate would be according to your income tax slab. It can be 0% or it can also be 30%.
The tax rate for long-term capital gains from debt mutual fund is 20%. It seems higher than the equity mutual fund, but It may be less burdensome as it enjoys the indexation benefit. The indexation enhances the purchase value of debt fund by factoring the inflation. Therefore, it reduces the profit which results in a lower tax.
Balanced Mutual fund
Balanced mutual funds invest in both, shares and bonds. However, these can be equity or debt oriented.
When it invests mostly in shares it would be equity oriented mutual funds. The tax rate of such balance fund would be same as equity mutual funds. 10% for the Long Term gains and 15% for the short term capital gains.
When a balanced mutual fund invests mostly in bonds it would be a debt-oriented balanced mutual fund. The tax rate would similar to the debt mutual funds. ‘20% with indexation’ for Long Term gains and your income tax slab rate for short-term capital gains.
When someone uses the term balanced mutual fund and there is no mention of orientation (Equity of debt), you should consider it as equity-oriented balanced mutual fund.
Tax Benefit of ELSS
ELSS or Equity Linked Saving Scheme is a special type of equity mutual fund. These funds also primarily invest in shares but it has the lock-in period of 3 years. During this period, you can’t get back your money.
These funds enjoy the benefit of tax deduction under section 80C. The amount you invest in ELSS is deducted from your taxable income. It reduces your tax liability. This tax benefit of ELSS is similar to EPF, PPF, insurance etc.
However, gains from the ELSS is treated like any other mutual fund. There would be a 10% tax on long-term capital gains if it exceeds ₹ 1 Lakh. Since, it has the lock-in of 3 years, there is no question of short-term capital gains.
Tax Treatment of SIP
SIP or Systematic Investment Plan is a way of mutual fund investment. In this method, you invest a fixed amount after a fixed interval. This interval can be weekly, fortnightly or monthly. However, people often keep it monthly as they get salary every month
You can adopt SIP method of investment for Equity, debt, balanced or ELSS funds. The tax rate also differs on the basis of these funds.
In the SIP, you make regular investments after a fixed interval. However, each investment is treated separately for taxation. Each investment would have its own Long Term period and short-term period.
Suppose you make a SIP investment of equity mutual fund for 2 years and sell all the units after this period. In this example, You have made a SIP for 2 years, but every monthly investment would have its own holding period. Only initial 12 payments would have made the Long Term Capital Gains. The next 12 investments would have made the Short Term Capital Gains. The tax rate would be different for the initial 12 investments.
The tax rate is different for the income which you earn because of the hard work. There is an income tax slab for such income. Every earning person should know the latest income tax slab to know the tax liability.