Taxation of mutual funds in India depends on the type of fund, holding period and chosen plan option (growth or dividend).
The tax consideration kicks in at the time of redeeming units of a fund. Selling units, withdrawing amount, switching between schemes or plan options, transacting under systematic transfer plan (STP) / systematic withdrawal plan (SWP) are all qualified as redemption for tax purposes.
For resident Indians, dividends received in excess of ₹5,000 are subject to 10% TDS.
Let us take a look at the tax treatment and rates (exclusive of any cess and surcharge) applicable for various fund categories.
Equity oriented mutual funds
These funds follow a mandate to invest at least 65% of their assets in domestic equity (stocks and/or their derivatives).
Sold within 1 year
Short-term capital gains tax is payable at the rate of 15%.
Sold after 1 year
Long-term capital gains exceeding ₹1 lakh per year are taxed at 10%.
Dividends
Dividends received are taxed as per the investor's income tax slab.
Non-equity oriented mutual funds
These funds are not required to invest at least 65% of their assets in domestic equity. The likes of debt funds, income funds, international funds, gold funds, fixed maturity plans (FMPs), etc. fall under this category.
Sold within 3 years
Short-term capital gains are taxed as per the investor's income tax slab.
Sold after 3 years
Long-term capital gains tax is payable at the rate of 20% with inflation indexation benefit. The cost is indexed against inflation as per
Cost Inflation Index (CII) and returns are adjusted accordingly. Thus tax has to be paid only on the inflation-adjusted gains (if any) and not on the actual absolute returns.
Inflation-adjusted Gain = Sale price - (Purchase price x CIIYear of sale / CIIYear of purchase)
Dividends
Dividends received are taxed as per the investor's income tax slab.
Exchange Traded Funds (ETFs)
The gains are taxed based on the underlying asset of an ETF - whether it is equity oriented or non-equity oriented. Tax treatment for both categories is the same as highlighted above.
Equity Linked Savings Scheme (ELSS)
These are also known as tax-saving or tax-saver funds. Investments of up to ₹1.5 lakh in ELSS funds qualify for tax deductions under Section 80C of the Indian Income Tax Act.
There is a lock-in period of just 3 years which is the lowest when compared to that of other alternatives providing similar tax relief.
The returns from ELSS are taxed exactly like equity oriented funds where long-term capital gains exceeding ₹1 lakh per year are taxed at 10%.
All these advantages make ELSS funds a worthy investment option as part of holistic financial planning.