Mutual Fund Taxation: Capital Gains and Dividends Explained: Some of you may have heard from your friends about the significant profits they have made by selling mutual funds. These profits are referred to as capital gains in terms of taxation, and they are now subject to taxation. The tax rate for capital gains on mutual funds depends on the type of asset and the holding period. This article will explain how taxes are applicable to mutual funds, looking at different parts like dividends and capital gains. We will focus on the tax rules applicable to equity-oriented funds, debt-oriented funds, hybrid funds, and also for investments made through regular plans (SIP). Knowing mutual funds taxation rules are important for investors to handle their investments well and get the best returns while following the tax laws.
Table of contents
- Changes in Mutual Fund Taxation (Budget 2023)
- Mutual Fund Types
- Taxation of Debt-Oriented Mutual Funds
- Taxation of Equity-Oriented Mutual Funds
- Taxation of Hybrid Equity-Oriented Mutual Funds
- Taxation of Hybrid Debt-Oriented Mutual Funds
- Taxation of Mutual Funds Through SIP
- Holding Period of Equity Funds and Debt Funds
Changes in Mutual Fund Taxation (Budget 2023)
Budget 2023 introduced significant changes in the taxation of mutual funds.
| Changes | Impact |
|---|---|
| No Indexation Benefits for Specified Mutual Funds | Mutual funds investing less than 35% in equity lose indexation benefits for calculating long-term capital gains. |
| Taxation of Long-Term Capital Gains | Previously taxed at a flat rate of 20% with indexation. Now taxed at applicable income tax slab rates from 1st April 2023 onwards. |
| Applicability for A.Y. 2024-25 | The changes in taxation will be applicable for taxpayers filing income tax returns for A.Y. 2024-25 onwards. |
No Indexation Benefits for Specified Mutual Funds: Under the new budget 2023, mutual funds that invest less than 35% of their funds in the equity shares of domestic companies will no longer be eligible for indexation benefits. Indexation is a method used to adjust the cost of acquisition for inflation, reducing the tax liability on long-term capital gains. However, with this change, investors in specified mutual funds will no longer have the option to avail of indexation benefits while calculating their long-term capital gains.
Previously, long-term capital gains from debt funds were taxed at a flat rate of 20% with the benefit of indexation. However, from 1st April 2023 onward, the advantage of indexation is removed. The gains are now included in the investor’s taxable income and taxed at the applicable income tax slab rate. The taxpayers who are filing income tax returns for A.Y. 2023-24, these changes will not be applicable.
Mutual Fund Types
Mutual funds can be broadly classified into two types: debt-oriented and equity-oriented mutual funds. Mutual fund taxation is totally different for each type of mutual fund.
| Mutual Fund Types | Taxation Treatment |
|---|---|
| Debt-Oriented Mutual Funds | Invest more than 65% of corpus in debt funds. Primarily invest in fixed-income instruments. Taxed as per applicable slab rates. |
| Equity-Oriented Mutual Funds | Invest more than 65% of corpus in equity shares. Tax treatment follows rules for equity funds. |
| Hybrid Equity-Oriented Mutual Funds | Combine equity and debt instruments. Tax treatment as equity-oriented if minimum 65% exposure to equity shares. |
| Hybrid Debt-Oriented Mutual Funds | Majority portfolio consists of debt instruments. Tax treatment follows rules for debt funds. |
1. Debt-Oriented Mutual Funds:
Debt-oriented mutual funds primarily invest in fixed-income instruments such as bonds, debentures, or government securities. The income earned from these funds is subject to taxation as per the applicable slab rates. Debt funds have a portfolio allocation where more than 65% of the fund’s assets are invested in debt securities. The remaining portion may be allocated to other instruments such as money market instruments or cash equivalents. The tax rules applicable to debt funds, including the taxation of dividends and capital gains, will be applied in this case.
2. Equity-Oriented Mutual Funds:
For taxation purposes, any mutual fund invests more than 65% of its corpus in equity shares of the company. This classification is important because it determines the tax treatment of the fund’s capital gains and dividends.
3. Hybrid Equity-Oriented Mutual Funds
Hybrid funds are a category of mutual funds that combine both equity and debt instruments in their portfolio. The tax treatment of hybrid funds depends on their allocation to equity and debt components.
If a hybrid fund has a minimum of 65% exposure to domestic company equity shares, it is treated as an equity-oriented fund for taxation purposes. In this case, the tax rules applicable to equity funds, such as the tax rates on capital gains and dividends, will be applied to the hybrid fund.
4. Hybrid Debt-Oriented Mutual Funds
On the other hand, if a hybrid fund has less than 65% exposure to domestic company shares and a majority of its portfolio consists of debt instruments, it is treated as a debt fund. The tax rules for debt funds, including the taxation of capital gains and dividends, will be applicable to such hybrid funds.
Taxation of Debt-Oriented Mutual Funds
Debt-oriented mutual funds are a type of mutual fund that primarily invests in fixed-income instruments such as bonds, debentures, government securities, and other debt securities. These funds aim to generate income for investors through interest payments and potential capital appreciation. Under the current tax regulations, a specified mutual fund refers to a mutual fund that invests less than 35% of its total proceeds in the equity shares of domestic companies.
Mutal Fund Taxation of Debt-Oriented Mutual Fund Table Summary
| Aspect | Taxation (Until 31st March 2023) | Taxation (From 1st April 2023) |
|---|---|---|
| Dividends | Taxable as per income tax slab rate | Taxable as per income tax slab rate |
| Short-Term Capital Gains (STCG) | Holding period: Less than 36 months Tax: Taxed at applicable income tax slab rate |
Taxed at applicable income tax slab rate |
| Long-Term Capital Gains (LTCG) | Holding period: 36 months or longer Tax: taxed at a flat rate of 20% with the benefit of indexation |
Included in taxable income, taxed at applicable income tax slab rate |
- Dividends: Dividends received from debt-oriented mutual funds are considered income and are subject to taxation. The dividend income is added to the investor’s regular income and taxed at the applicable income tax slab rate.
- Capital Gains: The taxation of capital gains from debt-oriented mutual funds depends on the holding period of the investment. The gains are classified as either short-term capital gains (STCG) or long-term capital gains (LTCG) based on the duration of holding.
- Short-Term Capital Gains (STCG): If the units of a debt-oriented mutual fund are held for less than 36 months (until 31st March 2023), the resulting gains are treated as short-term capital gains. These gains are added to the investor’s regular income and taxed at the applicable income tax slab rate.
- Long-Term Capital Gains (LTCG): If the units of a debt-oriented mutual fund are held for more than 36 months (until 31st March 2023), the resulting gains are treated as long-term capital gains. The long-term capital gains from debt funds were taxed at a flat rate of 20% with the benefit of indexation. However, from 1st April 2023 onward, the advantage of indexation is removed. The gains are now included in the investor’s taxable income and taxed at the applicable income tax slab rate. The taxpayers who are filing income tax returns for A.Y. 2023-24, these changes will not be applicable.
Impact of Recent Changes to Debt Fund Taxation on Different Income Tax Brackets
The recent changes (Applicable from 1st April 2023 i.e. for A.Y. 2024-25. The taxpayers who are filing income tax returns for A.Y. 2023-24, these changes will not be applicable) to debt fund taxation, which includes the removal of indexation benefits and the application of slab rates, can indeed have a varying impact on individuals, depending on their income tax brackets.
For individuals falling under the 20% or 30% tax brackets, the removal of indexation benefits can result in a higher tax liability on long-term capital gains from debt funds. Indexation allows investors to adjust the purchase price of the investment for inflation, reducing the taxable gains and ultimately lowering the tax burden. Without this benefit, the taxable gains may be higher, leading to a potential increase in the overall tax liability.
It’s important for investors to consider the mutual fund taxation of debt-oriented fundswhen planning their investments and tax obligations.
Taxation of Equity-Oriented Mutual Funds
Equity-oriented mutual funds are a category of mutual funds that primarily invest in equity shares of companies. These funds aim to generate capital appreciation by investing in stocks and securities of domestic and international companies.
Mutal Fund Taxation of Equity-Oriented Mutual Fund Table Summary
| Aspect | Taxation |
|---|---|
| Dividends | Taxable as per income tax slab rate |
| Short-Term Capital Gains (STCG) | Holding period: Less than 12 months Taxed at a rate of 15% |
| Long-Term Capital Gains (LTCG) | Holding period: 12 months or longer Gains up to Rs. 1 lakh tax-exempt Gains exceeding Rs. 1 lakh taxed at 10% (without indexation) |
1. Dividends: Dividends received from equity-oriented mutual funds are considered as income and are subject to taxation. The dividend income is added to the investor’s regular income and taxed at the applicable income tax slab rate.
2. Capital Gains: The taxation of capital gains from equity-oriented mutual funds depends on the holding period of the investment. The gains are classified as either short-term capital gains (STCG) or long-term capital gains (LTCG) based on the duration of holding.
– Short-Term Capital Gains (STCG): If the units of an equity-oriented mutual fund are held for less than 12 months, the resulting gains are treated as short-term capital gains. Currently, short-term capital gains from equity funds are taxed at a rate of 15%.
– Long-Term Capital Gains (LTCG): If the units of an equity-oriented mutual fund are held for more than 12 months, the resulting gains are treated as long-term capital gains. However, gains up to Rs. 1 lakh per financial year are currently tax-exempt. Any long-term capital gains exceeding this limit are taxed at a rate of 10% without the benefit of indexation.
It’s important to note that the taxation of equity-oriented mutual funds is based on the individual investor’s specific tax slab rates for dividends and capital gains. The rates mentioned above are applicable as per the current tax regulations, and they may be subject to change in the future.
Investors in equity-oriented mutual funds should be aware of the potential tax implications and consider them while planning their investments and tax obligations.
Taxation of Hybrid Equity-Oriented Mutual Funds
Hybrid equity-oriented mutual funds are a specific category of mutual funds that combine both equity and debt instruments in their portfolio. These funds have an equity allocation of at least 65% of their total assets, which classifies them as equity-oriented for taxation purposes.
The primary objective of hybrid equity-oriented funds is to provide investors with a balanced investment approach that offers the potential for capital appreciation through equity investments and income generation through debt instruments. The equity allocation allows investors to participate in the growth potential of equity markets, while the debt allocation provides stability and income.
Mutual Fund Taxation of Hybrid Equity-Oriented Mutual Fund Table Summary
| Aspect | Taxation (Until Current Regulations) |
|---|---|
| Dividends | Taxable as per income tax slab rate |
| Short-Term Capital Gains (STCG) | Holding period: Less than 12 months Taxed at a rate of 15% |
| Long-Term Capital Gains (LTCG) | Holding period: 12 months or longer Gains up to Rs. 1 lakh tax-exempt Gains exceeding Rs. 1 lakh taxed at 10% (without indexation) |
1. Dividends: Dividends received from hybrid equity-oriented mutual funds are considered as income and are subject to taxation. The dividend income is added to the investor’s regular income and taxed at the applicable income tax slab rate.
2. Capital Gains: The taxation of capital gains from hybrid equity-oriented mutual funds follows the same rules as equity-oriented mutual funds based on the holding period of the investment.
– Short-Term Capital Gains (STCG): If the units of a hybrid equity-oriented mutual fund are held for less than 12 months, the resulting gains are treated as short-term capital gains. Currently, short-term capital gains from equity funds are taxed at a rate of 15%.
– Long-Term Capital Gains (LTCG): If the units of a hybrid equity-oriented mutual fund are held for more than 12 months, the resulting gains are treated as long-term capital gains. However, gains up to Rs. 1 lakh per financial year are currently tax-exempt. Any long-term capital gains exceeding this limit are taxed at a rate of 10% without the benefit of indexation.
Taxation of Hybrid Debt-Oriented Mutual Funds
Hybrid debt-oriented mutual funds are a specific category of mutual funds that have a predominant allocation to debt instruments while also including a smaller allocation to equity instruments. These funds aim to provide investors with a blend of stability and income from debt investments along with potential capital appreciation from equity investments.
Mutual Fund Taxation of Debt Equity-Oriented Mutual Fund Table Summary
| Aspect | Taxation (Until 31st March 2023) | Taxation (From 1st April 2023) |
|---|---|---|
| Dividends | Taxable as per income tax slab rate | Taxable as per income tax slab rate |
| Short-Term Capital Gains (STCG) | Holding period: Less than 36 months Tax: Taxed at applicable income tax slab rate |
Taxed at applicable income tax slab rate |
| Long-Term Capital Gains (LTCG) | Holding period: 36 months or longer Tax: taxed at a flat rate of 20% with the benefit of indexation |
Included in taxable income, taxed at applicable income tax slab rate |
1. Dividends: Dividends received from hybrid debt-oriented mutual funds are considered as income and are subject to taxation. The dividend income is added to the investor’s regular income and taxed at the applicable income tax slab rate.
2. Capital Gains: The taxation of capital gains from hybrid debt-oriented mutual funds depends on the holding period of the investment and the allocation between debt and equity instruments.
– Short-Term Capital Gains (STCG): If the units of a hybrid debt-oriented mutual fund are held for less than 36 months (until 31st March 2023), the resulting gains are treated as short-term capital gains. These gains are added to the investor’s regular income and taxed at the applicable income tax slab rate.
– Long-Term Capital Gains (LTCG): If the units of a hybrid debt-oriented mutual fund are held for more than 36 months (until 31st March 2023), the resulting gains are treated as long-term capital gains. Previously, long-term capital gains from debt funds were taxed at a flat rate of 20% with the benefit of indexation. However, from 1st April 2023 onward, the advantage of indexation is removed. The gains are now included in the investor’s taxable income and taxed at the applicable income tax slab rate.
Taxation of Mutual Funds Through SIP
SIP Mutual Funds Taxation: Differentiating Between Debt and Equity Funds
When considering the taxation of SIP (Systematic Investment Plan) mutual funds, it is essential to distinguish whether the investments are made in debt mutual funds or equity mutual funds. This classification plays a significant role in determining the applicable tax rates on the capital gains realized from SIP investments.
As discussed earlier, the tax rules for debt and equity mutual funds are distinct.
A systematic Investment Plan (SIP) is a popular investment method offered by mutual funds that allow investors to invest a fixed amount regularly in a mutual fund scheme. SIPs provide a disciplined approach to investing and enable investors to accumulate wealth over time by investing in small increments at regular intervals.
| Aspects | SIP in Debt-Oriented Mutual Funds | SIP in Equity-Oriented Mutual Funds |
| Short-Term Capital Gains (Holding Period) | Less than 36 months | Less than 12 months |
| Long-Term Capital Gains (Holding Period) | 36 Months or Longer | 12 Months or Longer |
| Tax on Dividends | Taxable as per income tax slab rate | Taxable as per income tax slab |
| Tax on Short-Term Capital Gains | Taxed as per income tax slab rate | Taxed @15% |
| Tax on Long-Term Capital Gains | Taxed at a flat rate of 20% with indexation (up to A.Y.2023-24) | Gains up to Rs. 1 lakh tax-exempt, exceeding Rs. 1 lakh taxed at 10% |
| Amendments for A.Y. 2024-25 | Taxed per income tax applicable to taxpayers (w.e.f A.Y. 2024-25) | No Changes |
SIP in Debt-Oriented Mutual Funds vs SIP in Equity-Oriented Mutual Funds: A Comparison of Tax Implications
Systematic Investment Plans (SIPs) are a popular investment option for those looking to invest in mutual funds. However, the tax implications of investing in debt-oriented mutual funds and equity-oriented mutual funds through SIPs can vary. we will compare the tax implications of SIPs in debt-oriented mutual funds and equity-oriented mutual funds.
Short-Term Capital Gains
Short-term capital gains are gains made on the sale of mutual fund units held for a period of less than 36 months in the case of debt-oriented mutual funds, and less than 12 months in the case of equity-oriented mutual funds. The tax on short-term gains from debt-oriented mutual funds is as per the income tax slab rate applicable to the taxpayer, while for equity-oriented mutual funds, it is taxed at a flat rate of 15%.
Long-Term Capital Gains
Long-term capital gains are gains made on the sale of mutual fund units held for a period of 36 months or longer in the case of debt-oriented mutual funds, and 12 months or longer in the case of equity-oriented mutual funds. The tax on long-term gains from debt-oriented mutual funds is at a flat rate of 20% with indexation (up to A.Y. 2023-24), while for equity-oriented mutual funds, gains up to Rs. 1 lakh are tax-exempt and any amount exceeding Rs. 1 lakh is taxed at 10%.
Tax on Dividends
Dividends received from both debt-oriented and equity-oriented mutual funds are taxable as per the income tax slab rate applicable to the taxpayer.
Amendments for A.Y. 2024-25
For A.Y. 2024-25, there are some changes to the tax implications of SIPs in debt-oriented mutual funds. The tax on long-term gains will be as per the income tax slab rate applicable to the taxpayer. There are no changes to the tax implications of SIPs in equity-oriented mutual funds.
In conclusion, it is important to consider the tax implications when investing in mutual funds through SIPs. The tax treatment can vary depending on whether you invest in debt-oriented or equity-oriented mutual funds, and it is important to be aware of any changes to the tax laws that may affect your investments.
Holding Period of Equity Funds and Debt Funds
As we have discussed in complete detail about each type of mutual fund taxation above. But for a quick summary reason, here are the holding periods for each type of mutual fund. It helps you to quickly check the holding period for calculate tax on mutual fund capital gains.
| Fund Type | Short-term capital gains | Long-term capital gains |
| Equity Funds | Less Than 12 Months | More Than 12 Months |
| Debt Funds | Less Than 36 Months (Until 31st March 2023) | More Than 36 Months (Until 31st March 2023) |
| Hybrid equity-oriented funds | Less Than 12 Months | More Than 12 Months |
| Hybrid debt-oriented funds | Less Than 36 Months (Until 31st March 2023) | More Than 36 Months (Until 31st March 2023) |