Tax on Mutual Fund Returns in India

What will be the tax on mutual fund returns in India? To understand the tax treatment of mutual fund returns, we have to first answer a simple question.

In what forms, an investor can earn returns from mutual fund schemes? There can be two form of returns:

  1. Capital appreciation.
  2. Dividend income.

Capital appreciation is realised when the investor redeems (sells) his/her mutual fund units at profit.

How profit is booked? The investor sells units by self. The selling NAV is higher than they NAV at which the units were bought.

Dividend income is received periodically when the investor holds on to the mutual fund units for a specific period of time.

How dividend is received? The fund manager sells a part of the units for income. The income so earned by the mutual fund is distributed to the investors, in the proportion of their units (holdings), as dividends.

The above two returns becomes taxable as soon as it reaches in the hands of the investor.

How the returns earned from mutual fund are taxed?

What does the above flow chart say? I suppose reading the flow chart is simple. But anyways I pen down my understanding. This will help you to read the flow chart better.

#1. How Capital Gain is Taxed?

What is capital gain? Profit made from the sale of an investment, like mutual funds. Suppose you bought a mutual fund for Rs.10,000, and sold it for Rs.12,000. Then in this case your capital gain (profit) is Rs.2,000.

We will see here, how capital gain yielding from mutual funds is taxed in the below two cases:

  1. Equity Based Funds:
    • LTCG.
    • STCG
  2. Non-Equity Based Funds:
    • LTCG
    • STCG

#1.1a Equity Based Funds: LTCG

What are equity based mutual funds? Any fund whose average weightage of equity in the portfolio is more than 65%.

What is LTCG? Long Term Capital Gain. Profit made by the investor, when he/she holds on to the mutual fund units for a period of 36 months (3 years) or more, such a gain is considered as LTCG for tax treatment.

If the return is earned in the form of Long Term Capital Gain (LTCG), from equity fund, tax applicable will be @10% on the gains. But tax will be levied only if the capital gain is more than Rs.1.0 Lakhs.*

For capital gains below Rs.1.0 Lakhs, tax payable will be zero.

Return > Capital Gain (above 1.0 lakh) > Equity Fund > LTCG > 10%*

#1.1b Equity Based Funds – STCG

What is STCG? Short Term Capital Gain. Profit made by the investors, when he/she holds on to the mutual fund units for a period less than 36 months (3 years), such a gain is considered as STCG for tax treatment.

If the return is earned in the form of Short Term Capital Gain (STCG), from equity fund, tax applicable will be flat @15% on the gains.

Return > Capital Gain > Equity Fund > STCG > 15%

#1.2a Non-Equity Based Funds – LTCG

What are non-equity based mutual funds? Any fund whose average weightage of equity in the portfolio is less than 65%. Example: debt funds, money market funds, liquid funds, GILT funds etc.

If the return is earned in the form of Long Term Capital Gain (LTCG), from non-equity fund, tax applicable will be flat @20% (with indexation) on the gains.

Return > Capital Gain > Non-Equity Fund > LTCG > 20% with Indexation

#1.2b Non-Equity Based Funds – STCG

If the return is earned in the form of Short Term Capital Gain (STCG), from non-equity fund, tax applicable on the gain will be as per ones tax slab (@margial tax rate)

Return > Capital Gain > Non-Equity Fund > STCG > @Tax Slab*

*Example of Tax Payment as per applicable tax slab:

Suppose, a person’s net taxable income is Rs.4,99,000. This means, he is in 5% tax bracket.

Suppose the person earns a return of Rs.5,000 as STCG from a non-equity based funds.

In this case, the total taxable income of the person now becomes: Rs.(4,99,000 + 5,000) = Rs.5,04,000. This means, now the person has creeped into the 20% tax bracket.

Hence the income tax computation, as per margin tax rate, will be done as below:

0 to Rs 2,50,000 > NIL = Rs.0
2,50,001 to 5,00,000 > 5% of 2,50,000 = Rs.12,500.
5,00,001 to 5,04,000 > 20% of 04,000 = Rs.800

Total Tax Payable = Rs.(0+12500+800) = Rs.13,300

#2. How Dividend is Taxed?

What is divided income? Dividend funds, book profits occasionally. This profit is distributed among the investors in proportion of their holdings.

When NAV of mutual funds grows to a certain level within a period, the fund manager of a dividend focused fund, book profits as a rule. How NAV grows? In three ways:

  1. By increase in market value of securities in the portfolio.
  2. When dividend is earned from stocks held in the portfolio.
  3. When interest is earned from debt instruments held in the portfolio.

What it means by profit booking? A portion of mutual fund units are sold in the market.

We will see here, how dividend income from mutual funds is taxed in below two cases:

  1. Equity Based Funds.
  2. Non-Equity Based Funds.

#2.1a Equity Based Funds

Before 1st April’2018, dividend earned from equity based mutual funds were not taxable in India. But the amendment has been made to this rule, and subsequently, dividend from equity funds became taxable.

If the return is earned in the form of dividend, from equity fund, tax applicable will be @10% on the gains.

Return > Dividend > Equity Fund > 10%*

*Tax on Dividend = 10% + 12% Surcharge + 4% Cess = 11.648%.

#2.1b Non-Equity Based Funds.

Dividend income yielding from non-equity based mutual funds were always taxable. But there is a difference between dividend earned from equity based funds and non-equity based funds. What is the difference?

Tax of mutual funds in India - Dividend Equity Vs non equity funds3

If the return is earned in the form of dividend, from non-equity fund, the dividend so received is not taxable.

But the dividend from non-equity based funds is not taxable, in the hands of the investor, for a reason. What is the reason? Mutual fund has already deducted the DDT @25%.

Return > Dividend > Non-Equity Fund > No Tax*

*No Tax on Dividend because DDT @25% + 12% Surcharge + 4% Cess = 29.12% has already been deducted.

3 thoughts on “Tax on Mutual Fund Returns in India

  1. Prashantha Reply

    Hi,
    I think the STCG on equity MF is if the holding period is less than 12 months and not 36 months. The STCG on Non equity funds is if the holding period is less than 36 months.
    Also the LTCG on equity funds is calculated taking into account the grandfathered cost of acquisition based on the fund value on 31Jan 2018 for the units purchased before 31/01/2018.
    Please correct me if I am wrong.
    Regards,
    Prashantha

    • Mani Post authorReply

      For mutual funds, STCG is applicable when funds are held for less than 36 months.

      For LTCG calculation post 31-Jan’18, capital gains accrued till 31-Jan’18 is grandfathered.

      Thanks for asking.

  2. Jay Mehta Reply

    Investors are highly confused about how their investments will be taxed after LTCG. Some of them think that the 10 percent will be cut from their annualized returns, which is a wrong notion. Thanks for sharing a lot of useful info.

Leave a Reply

Your email address will not be published. Required fields are marked *