New Delhi. While investing in mutual funds, most people focus on returns, but ignore the tax. Whereas the actual earning is decided only after tax is deducted. There is no tax on investing or holding units in mutual funds, but when you sell, switch or redeem units, tax comes into play. This tax depends on the type of fund and holding period.
Why no tax on investments and holdings
There is no tax liability while investing money in mutual funds or holding units. Unlike fixed deposits, there is no tax on it every year. Tax is levied only when the investor makes profit and sells the unit. This profit is considered as capital gain and is taxed on it.
Tax rules on equity mutual funds
Mutual funds which invest more than 65 percent of their total assets in domestic stocks are considered equity oriented funds. If such a fund is held for more than a year, then the profit earned on it is called long term capital gain and is taxed at 12.5 percent. However, long term gains up to Rs 1.25 lakh in a financial year are not taxed. If the equity fund is sold before one year, then 20 percent tax has to be paid on short term capital gains.
How is tax levied on debt mutual funds?
Tax rules are more strict in debt mutual funds. These are those funds in which equity investment is less than 35 percent. In such funds, irrespective of the holding period, the profits are taxed as per the income tax slab of the investor. That means if you fall in a higher tax slab, the tax burden will also be higher.
Tax mathematics of hybrid funds
Hybrid funds invest in equity, debt and sometimes gold. Many hybrid funds are created in such a way that they come under the purview of equity taxation. Aggressive hybrid funds generally have 65–75 per cent equity, so they are taxed like equity. Balanced Advantage and Equity Savings Funds also maintain more than 65 per cent equity exposure through arbitrage, which gives them the benefit of equity taxation.
Tax on Gold, FoF and Dividend
Selling units in Gold ETF after 12 months is considered as long term capital gain and is taxed at 12.5%. In gold and silver fund of funds this period is 24 months. Investors choosing dividend i.e. IDCW option should keep in mind that the dividend received is fully taxable. By adding it to your total income, tax is imposed as per your tax slab.
Proper use of mutual funds to save tax
According to financial experts, investors can wisely use the LTCG exemption of Rs 1.25 lakh available every year. Tax can be saved by planning redemption at the right time. For fixed income investment, arbitrage funds and income plus arbitrage funds can become better options from tax point of view. At the same time, hybrid funds help in creating a balance between risk and tax. You will get better returns from mutual funds only when investment is made after understanding the tax rules. Right fund and right holding period is the biggest key to tax saving.
