If you have recently invested in mutual funds or are planning to do so, then understanding how the tax on mutual funds work is essential because it will help you understand the tax implications regarding mutual funds and, at the same time, save a lot of money. Just like any other securities or assets, the profits you will receive from mutual funds are taxable.
Avoiding taxes is difficult, but at the same time, people want to save their money and, in this case, the returns from the mutual funds’ investment. Therefore, knowing or understanding the rules of taxes before investing in any mutual fund scheme is important. Moreover, if you know the rules regarding mutual fund taxation, then you will be able to undertake a strategic approach and minimize your overall taxes.
Mutual fund taxation
Tax on dividends
Before March 31, 2020, the dividends received from mutual fund schemes were tax-free for investors, but in 2020, the Finance Act introduced an amendment stating that the mutual fund’s dividend income would be taxed. Thus the fund houses that manage the mutual fund declared a DDT or Dividend Distribution Tax which is deducted from the investors’ dividends.
Right now, the dividend income of the investors is taxable and is deducted according to the tax bracket of the income tax slab. TDS is also applicable to mutual funds. The Asset management company in charge of the mutual fund cuts down 10% TDS under section 194K (in case the total dividend paid to the investor in a financial year is more than Rs. 5000).
While you file for your taxes, you will be able to make a claim for the 10% TDS that was already deducted by the Asset management company.
Tax on capital gain
Another important tax on mutual funds that investors have to pay while investing in mutual fund schemes is the tax on capital gain. It also depends on the type of mutual fund you have invested in and the total duration of your investment. There are a total of two types of capital gain – long-term capital gains or LTCG and short-term capital gains or STCG.
To become eligible for long-term capital gains, an investor needs to hold on to their investment for at least one year in the case of equity-oriented schemes and three years for debt-oriented schemes. Anything less than that is considered short-term capital gains.
Final words
If you are someone who has heavily invested in mutual funds and is concerned about their returns getting reduced due to taxes, then you should learn how mutual funds get taxed. By learning about the taxation policies of different mutual fund schemes, you will be able to evaluate what kind of investment (be it short-term or long-term) will be advantageous for you (including the equity and debt funds).
You can also save taxes by directly investing in tax-saver mutual funds. You also need to note that taxation of mutual funds will remain the same even if you are investing through SIP (Systematic Investment Plan) or a lump sum investment plan. Nevertheless, investing in a mutual fund for the long term is more beneficial for an investor instead of investing for a short period.
