We all invest to get income on our investments in the form of Dividend or capital gains. And if there is income, there’s a tax. The tax on mutual fund investments depends upon the type of fund you’ve invested and how much time you hold it.
Here is what you ought to know about the taxation of Mutual Fund returns, especially Capital Gains Tax and tax on dividend income.
Taxation of Mutual Fund Capital Gains
Capital gain is the profit you make when you sell any investment including Mutual Funds. So if you invested Rs. 50,000 in a fund and it grew to Rs. 75,000 when you redeemed, Rs. 25,000 is the capital gain
The current Mutual Fund taxation rules divide capital gains into two different buckets, based on the duration in which these were generated — Long term Capital Gains (LTCG) and Short Term capital gains (STCG).
The definition of what duration is long term and short term and how much you will pay in taxes on redemption of Mutual Fund units is based on the fund type you invested in.
|Funds||Short term||Long term|
|Equity Funds||Less than 12 Months||12 Months and more|
|Aggressive Hybrid equity Funds||Less than 12 Months||12 Months and more|
|Other Hybrid Funds||if more than 65% of assets in equity, same as equity funds. Otherwise same as debt funds.|
|Debt Funds||Less than 36 Months||36 Months and more|
Now, let’s have a look at how capital gains are taxed for each category.
Capital Gains Tax Rules for Equity Mutual Funds
Long Term Capital Gain Tax
Any capital gains from Equity Mutual Funds held for over 12 months are treated as Long term capital gains and you have to pay 10% tax if those capital gains exceed 1 lakh in a financial year. Even then you pay 10% on the amount which is in excess of the Rs. 1 lakh limit
To understand it better, let’s take an example:
For instance: Mr. Raju invested Rs 50,000 on 1st Jan 2018 and when he redeemed on 1 Feb 2019, he received Rs. 75,000 as redemption value. Now his capital gain is Rs. 25,000 however as he stayed invested for at least 12 months and the gains didn’t exceed Rs. 1 lakh, he doesn’t need to pay any tax on the returns from the Debt Fund.
Now suppose he stayed invested for 4 years and redeemed when his investment value was Rs. 1,75,000. The capital gains on his investment are Rs. 1, 25,000 and he has to pay 10% on the amount exceeding Rs. 1 lakh. So the Capital Gains Tax he needs to pay will be just Rs. 2500 (10% of Rs. 25,000).
Short-Term Capital Gains Tax
If you sell your investment in equity funds within 12 months, the gains on selling them are treated as short-term capital gains (STCG) and taxed at 15 percent.
Here is an example.
Mr. Sharma invested Rs. 35,000 in an Equity Mutual Fund on 25 April 2020 and received Rs. 50,000 upon redeeming the investment on 22 Feb 2021.
Since the investment was held for less than 1 year, Rs. 15,000 generated as capital gains will be treated as short-term capital gain. So, he has to pay capital gains tax at 15% on Rs 15,000, that would be Rs. 2,250 plus health and education cess.
Capital Gains Tax Rules for Debt Mutual Funds
Short-Term Capital Gains Tax
Any gains realized from Debt Mutual Funds are treated as short term capital gain if the investment is sold within 36 months (3 years). These gains are added to your income and the tax on Mutual Fund returns depends on the income tax slab you fall in.
For instance, Sanjeev is in the 30% income tax bracket and he invested Rs 2 lakhs in a debt fund. After two years, he redeemed his investment for Rs. 2.5 lakhs. Since the fund units were held for less than 36 months (3 years), gains realized from the redemption will be treated as Short Term Capital Gains. So, he will have to pay Rs. 15,000 (30% of Rs. 50,000) as capital gains tax on the Debt Fund returns.
Long-Term Capital Gains Tax
Gains realized from debt mutual funds are treated as Long term capital gains if investments are held for more than 36 months. The long term capital gain is taxed at 20% after providing the indexation benefits on cost.
Indexation helps you to adjust the purchase price of a debt fund in order to reflect the impact of inflation on it. This adjustment increases your purchase price and therefore reduces your taxable capital gains. This means that you have to pay less tax on Debt Mutual Fund redemptions if you stay invested for 3 years or longer before redeeming.
For example, suppose Sanjeev invested Rs. 2 lakh in a Debt Fund in FY 2015-16 and stayed invested till FY 2020-2021. Then in FY 2020-2021, he redeemed his investment for Rs 2.5 lakh. Since he has stayed invested for over 3 years, his gains from the scheme will be considered as long-term gains, and the capital gains tax rate of 20% with indexation benefit will be applicable.
The below table shows how long-term capital gains tax on Debt Funds is calculated:
|Long Term Capital Gains Tax on Debt Fund|
|Investment in Debt Fund in FY 2015-16||₹ 2 lakh|
|Redeemed from Debt Fund in FY 2020-21||₹ 2.5 lakh|
|Capital Gains||₹ 50,000|
|Cost of Investment after adjusting for inflation (301/254)*200,000||₹ 2.37 lakh|
|Inflation adjusted Capital Gains||₹ 250,000 – ₹ 237,000 = ₹ 13,000|
|Long Term Capital Gains Tax payable at 20%||13,000 x 20% = ₹ 2600|
Tax on Dividend Income from Mutual Funds
Apart from capital appreciation, another way you can earn returns from Mutual Funds is through dividends. If you opt for the dividend plan of a Mutual Fund, the scheme will share the profits generated with you.
Dividends from both Equity and Debt Mutual Funds are taxable in the hands of the investor. Mutual Fund dividends are taxed as per the tax slab of the investor. So, investors in the 30% tax bracket will have to pay 30% tax on the dividends received.
Now that you know all about Mutual Fund taxation, with some planning, you can minimize the taxes you need to pay on your returns.
I received 7 lakh through mutual fund . I am sr. Citizen and non tax payer. Amt received 7 lak through mutual fund is taxable or not
Dear Rahul, thank you for your question. Mutual Funds returns are subject to Short or Long Term Capital Tax based on holding period and type of Mutual Fund that you have invested in. You can check the details in our blog on Mutual Fund Taxation. Also, you should download your Capital Gains Statement to figure out how much tax you will be required to pay on the amount you have received from Mutual Fund redemption.
Suppose you switch mutual funds within 1 year is there any tax? On gains
Dear Udit Thakker, thank you for your question. Yes, short-term capital gains tax is applicable to switch transactions. This is because, a switch from one scheme to another involves 2 transactions – a redemption of units of the source fund and an investment into the new scheme. As Capital Gains tax is applicable to redemption of Mutual Fund units, you will incur a tax liability on the gains.
The tax is directly deducted while redemption or we have to pay it separately ?
Dear Barun, thank you for your question. Mutual Fund redemptions are not taxed at source by the Fund House, so you have to declare the applicable gains at the time of filing your Income Tax Return and pay tax accordingly.
Very nice article. To the point and comprehensive, a tough combination to maintain.
I want to know more about indexation and the types of investment vehicles it is applicable for, appreciate if you could redirect me to the right resources.
Dear Ankit, thank you for your kind words and we are glad that you liked our blog. We actually have written a blog on Indexation earlier. Hopefully it will help you gain better understanding of the concept. Do let us know your thoughts.
If I am having a taxable income of Rs 12 lakhs and long term capital gain from equity mutual fund of 2 lakhs . what is the percentage of tax applicable to my 1 lakh capital gain (deducting 1 lakh for capital gain) for FY 2019-2020
Hey, Long term capital gain on equity will be taxed at the rate of 10% on the amount which is in excess of 1 lakh, so in your case, if long term capital gain is 2 lakh then 1 lakh is tax exempted and on the remaining 1 lakh you have to pay long term capital gain tax at the rate of 10%+ surcharge
For describe wonderful blog.
Great point,Very informative…
Cost of investment after adjusting for inflation calculation, I don’t understand that. Can you please explain more with example.
If you sell investments in debt funds after three years, the gains are treated as Long Term Capital Gains (LTCG). LTCGs are taxed at 20 per cent with indexation benefit. Indexation allows you to inflate the purchase price using the cost Inflation Index.
Suppose you have invested Rs 1 lakh in debt mutual fund scheme in February 2013 and sold it for Rs 1.4 lakh in May 2016. Since the investment was held for more than three years, it qualifies for long term capital gains taxes with indexation benefit.
To calculate the indexed cost, you would need CII of two financial years: the financial year in which the units are purchased (2012-2013) and the financial year in which it was sold (2016-17). CII is decided on a financial year basis. Financial year starts on 1st April and ends on 31st March of the subsequent calendar year.
Here’s the calculation for indexation cost:-
CII for 2012-2013= 852
CII for 2016-2017= 1125
Indexed cost = (CII for the year of sale/ CII for the year of purchase) X (Cost of purchase)
That means, in our example, it would be:
Indexed Cost = (1125/852) X (Rs 1 lakh) = Rs 1,32,042
As you can see, the calculation helped you to inflate your purchase price to Rs 1,32,042 from Rs 1 lakh for the purpose of calculating long term capital gains.
Your long term capital gains after indexation: Rs 7,958 (Rs 1,40,000 Sale Value – Rs 1,32,042 Indexed Cost).
That means indexation actually helped you to reduce your gains from Rs 40,000 (Rs 1,40,000 Sale Value – Rs 1,00,000 Purchase Price ) to just Rs 7,958.
The tax on gains also was reduced to Rs 1,592 (20 % of Rs 7,958) from Rs 8,000 (20 % of 40,000) if you haven’t indexed the purchase cost.
Hope it will help you!
I have say 10 different portfolios (sip). My question is LTCG is calculated against each portfolio separately or combined gains from all portfolios?
Mutual fund long term capital gain calculated separately by each fund housed where you have invested, but when you file your income tax, you have to show their consolidated long term capital gain for the financial year. However, you can get the consolidated capital gain statement from ETMONEY.
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