Explained – How to save tax on mutual fund investments

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New Delhi | Published: August 1, 2018 12:07:06 AM

One of the best ways to invest your money is investing in mutual funds (MF). Here’s how MF returns are taxed and possible ways to save tax on such returns.

How to save tax on mutual fund investments (Illustration: shyam)

One of the best ways to invest your money is investing in mutual funds (MF). Here’s how MF returns are taxed and possible ways to save tax on such returns. MFs come with two options: Growth and dividend. In growth MFs, returns will get re-invested and you get the returns when you sell your units. In dividend option, the returns are paid to unit holders in the form of dividend at regular intervals.

Equity and debt mutual funds

For taxation purposes, MFs are categorised into two buckets—equity and debt mutual funds. Equity MFs are those which invests 65% in equity-related instruments and remaining 35% in debt related securities. It includes index funds, large cap MF, mid-cap/small cap MF, diversified MF, global MFs and balanced MFs. Debt MFs are those which invest majorly in debt related instruments. It includes ultra short term debt funds, debt MFs, liquid funds, fund of funds.

How MF returns are taxed

We would categorise MF returns/gains taxation into three parts.

Dividend option: If you are investing in MFs with dividend option the returns from such dividend income is not taxable.

Equity funds with growth option: Redemption < 1 year – Short term capital gain: If you have invested in equity funds with growth option and sold / redeemed before one year, you are liable to pay short term capital gains tax. Currently, short term capital gain are 15% on the returns (4% cess additionally to be payable which would come to 15.60%).

Redemption > 1 year – Long term capital gains: If you sell or redeem your MFs after one year period, as per the newly inserted Section 112A via Finance Act 2018, if the amount of long- term capital gain exceeds `1 lakh, then the amount in excess of `1 lakh shall be chargeable to tax @ 10% without indexation (plus heath and education cess and surcharge). However, the application of Section 112A is subjected to certain conditions, one of it being the transfer should have taken place on or after April 1, 2018. All gains until January 31, 2018 have been “grandfathered”. So you can assume the new cost of holding your equity mutual funds is the closing price on January 31, 2018. The start date of your holding remains the original purchase date.

Debt MF with growth option

Redemption within 36 months – Short term capital gains: If you are selling or redeeming your debt mutual fund before 36 months, it is short term in nature and the profits are fully taxable. This means you need to add such profits / gains to your taxable income and pay income tax based on your income tax slab.

Redemption > 36 months – Long term capital gains: If you sell your debt mutual funds after 36 months, it is termed as long term capital gain. In such case, the tax would be paid at the rate of 20% after indexation benefit.

How to save tax on MF returns

There are several ways to save income tax on returns or gains from MFs.

Invest in equity MFs if you are a risk taker: Though equity MFs are risky, invest in top rated equity MFs for the long term. You would get capital appreciation and tax-free benefit up to a profit of `1 lakh.
Invest in debt funds if you have a low risk appetite: If you are a low risk taker, invest in debt MFs and take the advantage of indexation. Avoid investing for less than 36 months in debt MFs with growth option.
Invest in dividend options for regular income: If you are a senior citizen or looking for regular income, opting for dividend option in MF would help you to get a regular income. However, you should note that such income is not fixed. You may even get lower returns than bank fixed deposit rates in some cases.

By- Suresh KP, The writer is founder of Myinvestmentideas.com
Source: Tax Guru

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