Impact of Taxation on Mutual Funds

Over the years, Mutual Funds have gained the reputation of being profitable investments that help you reach your financial objectives. Also, Mutual Funds are known for their tax efficiency and ability to generate yield returns accordingly. Hence, while investing, it is crucial to consider the implications of taxation on Mutual Funds. Continue reading to learn more about the effect of a tax on Mutual Funds and how you can mitigate your tax liability.

Much like the returns from any other investment vehicle, returns on Mutual Funds are subject to taxation. The following variables will help you understand how Mutual Funds are taxed.

Type of Fund

How your Mutual Fund investment will be taxed depends on whether you’ve invested in equity-based or debt-oriented schemes.

• Capital Gains: The tax you pay on your Mutual Funds also depends on the capital gains, which is the profit earned by selling an asset at a higher rate than the buying price.
• Dividends: Dividends are portions of the accumulated profits the Mutual Fund house distributes to investors.
• Holding Period: The holding period refers to the duration between the buying and selling of Mutual Fund units. Usually, you have to pay less tax if the holding period is longer, encouraging investors to retain their investments for extended periods.

Investors earn profits from Mutual Funds through capital gains and dividends. Capital gains are taxed only upon redeeming Mutual Fund units, while dividends are taxed immediately.

Taxation on Dividends Earned on Mutual Funds

With the removal of the Dividend Distribution Tax (DDT) under the Finance Act of 2020, investors are now taxed on their full dividend income based on their income tax slab. Additionally, dividends are subject to Tax Deducted at Source (TDS). If your dividends exceed ₹5,000, the Asset Management Company (AMC) deducts 10% TDS. When filing your taxes, you can claim this TDS amount and pay only the balance due.

Taxation on Capital Gains on Mutual Funds

The tax treatment of capital gains earned from Mutual Funds depends largely on the type of scheme and the holding period.

Equity Funds

An Equity Fund is a Mutual Funds scheme that pools investments into shares of companies. Typically, these funds have an equity exposure of 65%. If you have invested in equity funds, any short-term capital gains earned on the same will be taxed at a rate of 20% if you sell units within a holding period of a year.

Alternatively, you earn long-term gains if you sell such units after a year. Such gains are tax-free up to ₹1.25 lakh p.a. Exceeding this threshold, long-term capital gains are subject to a tax of 12.5% without any indexation benefit. A 4% cess and a surcharge apply in both short-term and long-term capital gains.

Debt Funds

As of 1 April 2023, debt funds are not eligible for indexation benefits and will be treated as short-term capital gains. The returns from the debt fund will be combined with your taxable income and subject to taxation at your applicable income tax slab rate.

Now that you better understand how income tax on Mutual Funds works, you can invest accordingly and file your returns in compliance with tax laws. To invest in tax-efficient Mutual Funds, head straight to HDFC Bank and open an Investment Services Account today!

* Terms and Conditions apply. The information provided in this article is generic in nature and for informational purposes only. It is not a substitute for specific advice in your circumstances. You are recommended to obtain specific professional advice before you take any/refrain from any action.