Understanding How Returns On Mutual Funds Are Taxed

Currently, dividends earned from equity mutual funds are tax-free for investors.

Updated on: 10 August 2019 5:47 am

Investors, who have a strong mutual fund portfolio, must have a very good understanding of how their returns are taxed. Currently, dividends earned from equity mutual funds are tax-free for investors. Dividends are paid by fund houses after deducting a dividend distribution tax of 11.648% including surcharge and cess.

To start with any mutual fund units held by the investors, are divided into short-term and long-term units. When it comes to equity mutual funds and balanced mutual funds, if held for more than 12 months it falls under long-term investment category and attracts long-term capital gains tax(LTCG)

It is important to note that gains exceeding Rs. 1 lakh a year on equity funds would attract 10 % tax without the benefit of indexation. This was introduced in budget 2018, where investment in equity mutual funds or shares before 31 January 2018 is grand-fathered. The equity funds units, which are redeemed before 12 months, would attract 15% tax. When it comes to tax saving equity funds commonly known as equity-linked saving scheme (ELSS) has a lock-in period of three years. Post redemption after 3 years, the LTCG up to Rs. 1 lakh is tax-free for ELSS. Any excess of Rs. 1 lakh would attract 10% tax without the benefit of indexation.

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For debt funds, long-term capital gains is regarded as investment held for 36 months or more and they are taxed at 20% with indexation benefit. Indexation is adjustment of gains after taking inflation into consideration. Further returns arising from sale or redemption of debt funds within 36 months of holding are treated as short-term capital gains. Similarly, for equity mutual funds holding period of less than 12 months is defined as short-term. Although dividends from debt mutual funds are tax-free, they are subjected to a dividend distribution tax of 29.12% including cess and surcharge. That said, a securities transaction tax (STT) of 0.001% is levied on the equity oriented mutual fund by the fund house. However there is no STT when it comes to the sale of debt funds.