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The capital gains tax imposed on mutual funds confuses most investors. Actually, tax rules are different for different categories of funds and the holding period also makes a big difference. Be it equity or debt, the tax treatment on every fund is different, so it is important to understand these rules before investing.
New Delhi. The biggest problem faced by investors is that on which type of mutual funds there is tax and which type of mutual funds there is no tax. While capital gains tax is applicable on redemption of mutual funds, it is not uniform. It depends on the category of the fund and for how long the investment is held. The rules are simple – higher tax on short-term gains and lower tax on long-term gains. But the specifics of every fund are different. As per the current structure, short-term capital gains are taxed at 20 per cent, while long-term gains are taxed at the rate of 12.5 per cent. These rates are applicable to both equity and debt funds, but the difference in exemption limit and holding period makes them different.
Equity mutual funds: Heavy tax on selling before one year
Equity mutual funds are those in which at least 65 percent of the investment is in shares. If these funds are sold within a year, the gain is considered short-term and is taxed at the rate of 20 percent. If investors sell after completion of one year, it becomes long-term gain and 12.5 per cent tax has to be paid on profits above Rs 1.25 lakh. These rules apply to all equity-oriented funds that have high exposure to stocks. Therefore, it is important for small-time investors to understand that withdrawals within a short period may result in higher tax implications.
Tax on debt funds: Big difference between new and old investments
Debt mutual fund is also called income fund. They mainly invest in government bonds, corporate debt and other fixed-income instruments. Tax rules are different for them. Debt funds purchased before April 1, 2023, and held for more than 2 years are subject to long-term capital gains tax at the rate of 12.5 per cent. At the same time, if sold in less than 2 years, short-term gain is made and tax is levied as per the income tax slab of the investor. But a major change has been implemented on debt funds purchased after April 1, 2023. Now the holding period does not matter. Any profit is fully taxable as per income tax slab. That means it has more impact on HNIs and investors in higher tax brackets.
What are the lessons for investors?
Before investing in mutual funds, it is important to understand that tax directly affects your net returns. Equity funds are beneficial in terms of tax in the long run, while the tax burden on debt funds may increase after the recent rules. The investor should decide what his investment objective is – short-term or long-term. Because this alone does not determine the tax liability, but the overall category of the fund and the date of purchase also have an impact. Choosing the right fund and right time can ensure better returns along with tax savings.
