Overview - Taxes on Mutual Funds
When you’re calculating your returns from a mutual fund investment, don’t forget to calculate your tax liabilities! Many people forget about the tax implications when calculating their returns. So the answer to the question - do I pay tax on mutual funds - is yes, but it depends and there can be exceptions. Remember, you are taxed on your capital gains i.e. how much money you made. If you withdraw at a loss, you won’t be taxed (but we highly recommend you don’t withdraw at a loss!)
We’ll look at the various taxes that you may have to pay (please note - these are general and you should take the advice of a tax advisor).
Equity Mutual Funds Tax
If you’ve invested in equity funds, your taxes will be categorized by the length of your investment:
Less than 12 months
If you withdraw and sell your investment less than a year after investing, any gains you made will be taxed according to ‘short term capital gains’ at 15%.
More than 12 months
After one financial year, any capital gains are taxed at 10% as they are considered ‘long term capital gains’. You will be taxed at this rate only when you sell/withdraw your investment from the mutual fund.
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Debt Mutual Funds Tax
If you’ve invested in a debt mutual fund, your taxes will be slightly different to equity funds:
Less than 3 years
For debt funds, the short term capital gains bracket is up to 3 years. If you decide to withdraw your investment less than three years after investing, any capital gains you made through your investment will be considered as income and added to your income for the tax year. For example, if you made 25 lakhs as salary, and withdrew a 5 lakh gain on a debt investment (that is in its 2nd year), your income for that year will be effectively 30 lakhs. This can change your tax bracket, so be careful!
More than 3 years
After three years, your investment is considered long term capital gains. Therefore, you are taxed at 20% when you withdraw and sell your investment in a debt mutual fund. However, you get indexation benefit when you do this! Indexation benefit accounts for inflation, therefore it increases the price that you paid to invest in the mutual fund, which reduces your tax liability by a large amount. For example, if you invested Rs. 10 lakhs in a debt mutual fund 10 years ago, and have made a gain of Rs. 5 lakhs when you withdraw, you wouldn’t pay tax on Rs. 5 lakh of capital gains. Instead, indexation benefit would increase the original purchase cost to Rs. 12 lakhs (as an example), meaning you pay 20% tax on Rs. 3 lakhs rather than Rs. 5 lakhs (even though you have pocketed Rs. 5 lakhs!).
Tax Saving ELSS Funds
One interesting thing to note is that if you invest in tax-saving mutual funds, known as ELSS funds, you can get a tax exemption on your annual taxes. ELSS funds are mutual funds that invest in equities, and if you invest in them, you will get an exemption of the amount you have invested (up to the annual maximum limit of Rs. 1,50,000) on your annual tax liability!
Taxes on SIPs
When you invest through a SIP, every installment is treated as a separate investment. So, pro rata, each month (if doing a monthly investment) will be the first date for that particular investment. So, 12 months after your first installment in an equity fund, only that installment will be considered for long term capital capital gains.
Securities Transaction Tax (STT)
When you sell your investment in an equity or hybrid-equity fund, you will also have to pay an additional 0.001% Securities Transaction Tax. This tax isn’t applied to debt funds.
Taxes on Balanced Funds
Some funds have a combination of equity and debt - so it is natural to wonder if they count as debt or equity funds for your taxes. It depends on the orientation of the fund (which the fund will tell you). A debt oriented balanced fund will have gains taxed as a debt fund, and an equity oriented balanced fund will have gains taxed as an equity fund.
Mutual Funds Tax for NRIs
NRIs are taxed according to the exact same brackets mentioned above, with the same short term and long term thresholds. However, there are different forms of repatriating those gains depending on if you invest through a NRE or NRO account.
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