INCOME TAX: 2023-24
Five major announcements for Income Taxpayers:
- New tax regime to become the default tax regime
- No tax on income up to Rs 7 lakh a year in the new tax regime
- Govt proposes to increase the income tax rebate limit from Rs 5 lakh to Rs 7 lakh in the new tax regime
- Four new slabs in the new tax regime
- No income tax till Rs 3 lakh income
New slabs under new tax regimes
- Rs 0-3 lakh -> Nil
- Rs 3-6 lakh -> 5%
- Rs 6-9 lakh -> 10%
- Rs 9-12 lakh -> 15%
- Rs 12-15 lakh -> 20%
MUTUAL FUND TAXATION: 2023-24
Mutual Fund Taxation – How Mutual Funds Are Taxed?
Mutual funds are one of the most buzzing investment options as they help you achieve your financial goals. Mutual funds are also tax-efficient instruments. Investing in fixed deposits is a great disadvantage, particularly if you fall under the highest income tax bracket, as the interest is added to your taxable income and taxed at your income tax slab rate. This is where mutual funds score better. When you invest in a mutual fund, you get the benefit of expert money management and tax-efficient returns.
Latest Update:
Budget 2023: No indexation benefit will be available while calculating long-term capital gains on a Specified Mutual Fund (i.e. a mutual fund that invests less than 35% of its proceeds in the equity shares of domestic companies). Debt mutual funds will now be taxed as per the applicable slab rates.
What is Tax on Mutual Funds?
Profits gained from investment in mutual funds are subject to tax as ‘Capital gains’. So, before investing in mutual funds, you should clearly understand how your returns will be taxed. Moreover, you can also avail tax deductions in certain cases.
What are the Factors to Determine Tax on Mutual Funds?
Taxation on mutual funds can be explained further by pointing out the factors influencing it. Here are the essential factors that affect the taxes levied on mutual funds:
- Fund types: Taxes are levied on two types of mutual funds. They are debt-oriented and equity-oriented mutual funds.
- Dividend: A part of the profit distributed amongst investors by mutual fund houses is called the dividend.
- Capital gains: When investors sell their capital assets at a higher price than their total investment amount, the profit is termed capital gains.
- Holding period of investor: Time between the date of the purchase and sale of mutual fund units. As per the income tax regulations of India, if you hold your investment for an extended period, you will be liable to pay a low tax amount. Thus, the holding period influences the tax rate payable on your capital gains. The higher your holding period, the lesser the tax you are liable to pay.
How Do You Earn Returns in Mutual Funds?
Mutual funds offer returns in two forms: Dividends and Capital gains.
Dividends are paid out of the profits of the company, if any. When the companies are left with surplus cash, they may decide to share the same with investors in the form of dividends. Investors receive dividends proportional to the number of mutual fund units held by them.
A capital gain is the profit realized by investors if the selling price of the security held by them is greater than the purchase price. In simple terms, capital gains are realized due to the appreciation in the price of the mutual fund units. Both dividends and capital gains are taxable in the hands of investors of mutual funds.
Taxation of Dividends Offered by Mutual Funds
As per the amendments made in the Union Budget 2020, dividends offered by any mutual fund scheme are taxed classically. That is, dividends received by investors are added to their taxable income and taxed at their respective income tax slab rates.
Previously, dividends were tax-free in the hands of investors as the companies paid dividend distribution tax (DDT) before paying dividends.
Taxation of Capital Gains Offered by Mutual Funds
The tax rate of capital gains of mutual funds depends on the holding period and type of mutual fund. Capital gains realized on selling units of mutual funds are categorized as follows:
| Fund Type | Short-term capital gains | Long-term capital gains |
| Equity funds | Shorter than 12 months | 12 months and longer |
| Debt funds | Always short-term | |
| Hybrid equity-oriented funds | Shorter than 12 months | 12 months and longer |
| Hybrid debt-oriented funds | Always short-term | |
| Fund type | Short-term capital gains | Long-term capital gains |
| Equity funds | 15% + cess + surcharge | Any gains above Rs 1 lakh are taxed at 10% + cess + surcharge |
| Hybrid equity-oriented funds | ||
| Debt funds | Investor’s income tax slab rate | Investor’s income tax slab rate |
| Hybrid debt-oriented funds |
Taxation of Capital Gains of Equity Funds
Equity funds are those mutual funds where more than 65% of it total fund amount is invested in equity shares of companies. As mentioned above, you realize short-term capital gains if you redeem your equity fund units within one year. These gains are taxed at a flat rate of 15%, irrespective of your income tax bracket.
You make long-term capital gains by selling your equity fund units after holding them for over one year. These capital gains of up to Rs 1 lakh a year are tax-exempt. Any long-term capital gains exceeding this limit attract LTCG tax at 10%, without indexation benefit.
Taxation of Capital Gains of Debt Funds
Debt funds are those mutual funds whose portfolio’s debt exposure is more than 65% and equity exposure is not more than 35%. Starting 1st April 2023, the debt funds will no longer receive indexation benefits and deemed to be short-term capital gain. Therefore, the gains from debt funds will now be added to your taxable income and taxed at the slab rate.
Earlier, the long-term capital gains from debt funds were taxed at 20% with indexation benefits.
Taxation of Capital Gains of Hybrid Fund
The rate of taxation of capital gains on hybrid or balanced funds is dependent on the equity exposure of the portfolio. If the equity exposure exceeds 65%, then the fund scheme is taxed like an equity fund, if not then the rules of taxation of debt funds apply.
Therefore, it is essential to know the equity exposure of the hybrid scheme you are investing in, if not then you might be in for a nasty surprise on redemption of your fund units.
Taxation of Capital Gains When Invested Through SIPs
Systematic investment plans (SIPs) are a method of investing in mutual funds. They are designed in such a way that investors can invest a small amount periodically in a mutual fund scheme. Investors are offered the liberty to choose the frequency of their investment. It can be weekly, monthly, quarterly, bi-annually, or annually.
You purchase a certain number of mutual fund units through every SIP instalment. The redemption of these units is processed on a first-in-first-out basis. Suppose you invest in an equity fund through a SIP for one year, and you decide to redeem your entire investment after 13 months.
In this case, the units purchased first through the SIP are held for the long term (over one year) and you realize long-term capital gains on these units. If the long-term capital gains are less than Rs 1 lakh, then you don’t have to pay any tax.
However, you make short-term capital gains on the units purchased through the SIPs from the second month onwards. These gains are taxed at a flat rate of 15% irrespective of your income tax slab. You will have to pay the applicable cess and surcharge on it.
Securities Transaction Tax (STT)
Apart from the tax on dividends and capital gains, there is another tax called the Securities Transaction Tax (STT). An STT of 0.001% is levied by the government (Ministry of Finance) when you decide to buy or sell mutual fund units of an equity fund or a hybrid equity-oriented fund. There is no STT on the sale of debt fund units.
Conclusion
The longer you hold on to your mutual fund units, the more tax-efficient they become. The tax on long-term capital gains is comparatively lower than the tax on short-term gains.