Equity mutual fund taxation: All you need to know

In the vast landscape of personal finance, investing in equity mutual funds can be compared to nurturing a beautiful garden. Just as a garden requires time to flourish, equity funds have the potential to grow your wealth in the long run. However, it is crucial to understand the tax implications that accompany such growth. Let us understand equity mutual fund taxation and explore the various exemptions and factors that influence the taxation process.

• Table of contents

1. What are equity funds?
2. How are equity mutual funds taxed?
3. More about mutual fund taxes
4. What are the factors determining tax on equity mutual funds?
5. How returns are generated in equity mutual funds

What are equity funds?

Equity funds are mutual funds that invest in the stocks of various companies. These funds pool money from multiple investors and invest it in a diversified portfolio of equity instruments.
Equity funds are managed by professionals who utilise their expertise to carefully select stocks and navigate the dynamic nature of the stock market. This allows investors to access a diverse range of equities, regardless of their individual investment knowledge or the amount of capital at their disposal.

How are equity mutual funds taxed?

While many investors focus majorly on the potential return from their investment, they often tend to overlook the tax consequences when deciding on an investment plan. However, understanding the tax exemptions before investing is always advisable. Equity mutual funds are aimed at encouraging long-term investment and promoting economic growth.

More about mutual fund taxes

The potential gains you make when you sell mutual fund units – that is, the difference between purchase price and sale price – are known as capital gains. Gains on units that were held for more than a year are considered long-term capital gains (LTCG) for taxation purposes. The LTCG tax on equity mutual funds is 10% (plus surcharges and cess) on gains exceeding Rs.1 lakh in a financial year. However, gains up to Rs. 1 lakh are exempt from taxation.

Short-term capital gains (STCG) tax

Short-term capital gains are the gains made on the sale of equity assets held for less than a year. The taxation on these is higher than that on LTCG. Short-term capital gains or STCG are taxed at 15% (plus surcharges and cess), regardless of the investor's income bracket. This aims to discourage frequent trading and promote long-term investment.

For example, if you have a taxable annual income of Rs 7,00,000 and earn Rs 1,00,000 through the sale of equity mutual fund units held for under a year, you will be taxed as per your tax slab on Rs 7,00,000 and will pay a flat rate of 15% (plus surcharges and cess) on Rs 1,00,000.

Equity-Linked Saving Scheme (ELSS)

Equity-Linked Saving Scheme (ELSS) is a category of equity mutual funds that offers tax benefits under Section 80C of the old regime of the Income Tax Act, 1961. ELSS investments of up to Rs 1.5 lakh in a financial year are eligible for deduction from the investor's taxable income.

SIPs allow investors to invest a fixed amount at regular intervals. Each SIP investment is considered a separate investment for the purpose of tax computation.

More about mutual fund taxes

Debt funds

Debt funds primarily invest in fixed-income securities like bonds and treasury bills. Since 2023, capital gains from debt funds are taxed as per the investor’s income tax slab regardless of the holding period.

Dividends

Dividends from mutual funds are taxable in the hands of the investors. The dividend income is added to the investor’s total income and taxed as per their income tax slab rates. Additionally, the mutual fund company deducts a 10% TDS (tax deducted at source) if the dividend pay-out exceeds Rs. 5,000 in a financial year. However, investors can claim a rebate on this when filing their returns, if eligible.

What are the factors determining tax on equity mutual funds?

The tax implications of equity mutual funds are influenced by various elements. Understanding these factors is essential for an investor to thoughtfully manage tax liabilities.

Holding period: The duration for which you hold equity mutual fund units plays a vital role in determining the tax treatment. As mentioned earlier, long-term capital gains are usually subject to a more favourable tax rate compared to short-term capital gains.

Tax rate: The tax rate applied to your gains depends on the prevailing tax laws. It is essential to stay updated with any changes in tax regulations to effectively plan your investments.

Income Distribution cum Capital Withdrawal (IDCW): Some equity mutual funds distribute IDCW to their unit holders. IDCW is taxable as per the applicable tax rates and must be reported in your income tax return

How returns are generated in equity mutual funds

Returns for equity mutual fund investors chiefly stem from two sources: capital gains and dividends.

Capital gains come from the increase in the value of a portfolio’s underlying securities. In other words, if the value of the stocks held by the mutual fund scheme increases, the scheme’s net asset value rises. Investors profit if they sell their mutual fund units at a higher NAV than what they purchased it for.

Dividends, meanwhile, come when companies distribute a portion of their profits to shareholders. These dividends are passed on to the mutual fund that has invested in that company’s stocks.

Conclusion:

Equity mutual funds have the potential to grow your wealth over time. However, just like a gardener must carefully counter various conditions to maintain the health of their garden, understanding the taxation aspects of equity funds is vital for maximising your return potential. Equity mutual fund taxation offers exemptions and benefits that can enhance the growth of your investments.
From long-term capital gains tax benefits to potential tax deductions on specific schemes, these provisions can act as a catalyst for long-term wealth creation. Therefore, you can effectively plan your investments and optimise your tax liabilities by grasping the factors that influence equity mutual fund taxation, such as the holding period, tax rates, dividends.

FAQs:

How are long-term capital gains from equity funds taxed?

Long-term capital gains from equity funds, i.e., if the investment is held for over one year, are taxed at a rate of 10% without indexation benefit.

What is the tax rate on short-term capital gains from equity funds?

Short-term capital gains from equity funds, held for less than a year, are taxed at a rate of 15%.

Are equity oriented mutual funds taxable?

Equity mutual funds taxation holds true under most circumstances. On equity funds held for more than a year, long-term capital gains are taxed at 10% plus any applicable cess and surcharges. Equity funds with short-term capital gains that have been held for less than a year are taxed at the applicable income tax slab rate for the individual.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.