Mutual Funds Taxation

Mutual Funds taxation

Chapter 8 – Mutual Funds Taxation

A profit from a sale of investment (here its mutual fund in our case) is called capital gain. Based on the duration and type of mutual fund you hold the capital gain is classified into 2 types.

1. Long Term Capital gain (LTCG)

The criteria of long term capital gain are different for equity and debt instruments for taxation purpose in India.

a. LTCG – Equity

• For equity instruments, long term capital gain (LTCG) is defined as profit from sale of equity mutual fund that is held for more than 1 year. As per Union budget for 2018-19, LTCG from equities are taxable on capital gains of Rs 1 lakh and above on sale of equity shares & equity oriented mutual fund. Gains are taxed @ 10% without giving the benefit of indexation.

• Capital gains tax until 31 January 2018 will be grandfathered.
For instance, if you have invested in an equity fund with NAV of Rs.10 on August 9, 2017 and the price of NAV has grown to Rs.15 on January 31, 2018. Today, if you redeem after your investment completes one year, say on 10th Aug 2018 and the NAV on that day is Rs.18, then you will have to pay tax on Rs.3 (18-15) instead of Rs.8 (18-10) as the date of acquisition has changed from the actual date (August 9, 2017) to the grandfathered date (January 31, 2018). The tax will have to be paid only on the Gains exceeding Rs. 1 lakh.

• It must be noted that a fund qualifies to be an equity mutual fund if it holds more than 65% of its portfolio in equity.

b. LTCG – Debt

Any mutual fund that holds less than 65% equity in its portfolio will be considered under debt category. For debt instruments long term capital gain is defined as a profit from sale of Non – equity mutual fund that was held for more than 3 years. As per Union budget for 2017-18 LTCG from Non- equity mutual funds are taxable at 20% with indexation benefit.

2. Short Term Capital Gain

a. STCG – Equity

For equity instruments, short term capital gain is defined as profit from sale of equity mutual fund that was held for less than 1 year. As per Union budget for 2017-18 STCG from equities are taxed at a rate of 15%.

b. STCG – Debt

For debt instruments short term capital gain is defined as a profit from sale of Non – equity mutual fund that was held for less than 3 years. As per Union budget for 2017-18 LTCG from Non- equity mutual funds are taxable at individual’s current tax slab without any indexation.

Tax Impact on Dividend pay-out:

In mutual funds dividend is not an additional benefit like we get in equities because whenever there is a dividend pay-out happens, the dividend is deducted from NAV value. Hence dividends in mutual funds should be considered as a part profit booking at regular intervals. For an example if a fund with an NAV value ₹150 declares a dividend of ₹10 today, after the dividend pay-out the NAV value will be reduced by ₹10 and new NAV value will be ₹140.

It must be noted that there is no dividend distribution tax for equity mutual funds whereas debt funds pay around 28.84% as tax out go for dividends (This tax is paid by mutual fund house).

Tax Impact on Dividend Reinvestment:

In Mutual fund’s dividend reinvestment schemes, the declared dividend is again reinvested in the same mutual fund by the mutual fund house instead of issuing a pay-out to the investor. The NAV for reinvested amount will be equal to NAV of the mutual fund’s dividend option scheme.  For an example if I own 1000 units of a fund with an NAV value ₹150 declares a dividend of ₹10 today, after the dividend pay-out the NAV value will be reduced by ₹10, new NAV value will be ₹140 and a dividend of ₹10, 000 (10*1000) will be issued and in dividend reinvestment scheme this amount will be used to purchase the same mutual fund at NAV of ₹140. Thus additional units of 71.43 will be added to initial 1000 units.  So new number of units in hand will be 1071.43.

For equity mutual funds dividend doesn’t have any tax but for debt mutual funds dividend are taxed at 28.84% to the mutual fund house. Though this is not directly paid by us it will have an impact on cost.  Though this is not a sensible option for investors in 5% and 20% bracket, this will marginally benefit people in 30% tax slab.

Back to Chapter 7 – Terminologies of Mutual Funds

Continue to Chapter 9 – Mutual Funds Ratio

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