HOW ARE CAPITAL GAINS TAXED ON MUTUAL FUND INVESTMENTS?
Investors worldwide choose to invest in mutual funds for the multiple benefits it offers to investors. Several individuals invest in mutual funds online without considering the post-tax implications on their investments. This results in their lower returns than anticipated which often leads to disappointment. To avoid this situation, it is always recommended to consider the post-tax returns on your investments. In this article, we will understand how capital gains are taxed on different types of mutual funds.
Mutual fund investments provide investors yield on their investments in two ways – dividends and capital gains. When a company is endowed with surplus cash, it may decide to shower their investors with the same in the form of dividends. An investor is likely to receive dividends in proportion to the mutual fund units held by them. On the other hand, an investor earns capital gains when they redeem their mutual fund investments at a price higher than they purchased it. In simple words, an investor enjoys capital gains when the price of their mutual fund units appreciate in value. As per the recent tax amendments, both capital gains and dividend distribution tax (DDT) are taxable at the hands of investors.
Taxation of dividends
As per the recent revisions realised in the Union Budget 2020, dividends offered by a mutual fund scheme is taxed in the hands of the investor in a classical manner. Initially, investors didn’t have to worry about dividends distribution tax as the companies paid DDT tax before distributing any dividends to its investors.
Taxation of capital gains
The taxation of capital gains offered by mutual fund schemes is dependent on two factors, namely, their holding period and the type of mutual fund. Holding period is simply the investment duration for which an investor holds the mutual fund units. It plays a significant role in governing the tax implications on a particular mutual fund scheme. Different types of mutual funds have varying conditions for what establishes a short-term investment horizon and a long-term investment horizon. The following table will explain the capital gains realised on redeeming mutual fund units:
| Type of mutual fund | Short-term capital gains | Long-term capital gains |
| Debt mutual funds | Lesser than 3 years | Equal to or more than 3 years |
| Equity mutual funds | Lesser than a year | Equal to or more than a year |
Taxation of equity funds
Short-term capital gains (STCG) on equity investments are taxed at 15% p.a. On the other hand, long-term capital gains (LTCG) on equity funds are taxed at 10% p.a. for capital gains exceeding Rs 1 lac p.a. LTCG on equity funds up to Rs 1 lac in a particular financial year are exempt from any type of tax.
Taxation of debt funds
Short-term capital gains (STCG) on debt funds are added to the taxable income of an investor and taxed basis their prevailing tax slab rate. Conversely, long-term capital gains (LTCG) on debt investments are taxed at 20% p.a. with the added benefit of indexation.
Before you choose between different mutual fund investment plans offered to you, it is imperative that you consider their post-tax implications to get a clear picture on the actual yields expected to be enjoyed by you after a period of time. Happy investing!