How are Mutual Funds Taxed? Taxation of Mutual Funds Explained.

Mutual funds returns are subject to 2 types of taxes — Dividend Distribution Tax (DDT) and Capital Gains Tax. Capital Gains Tax also come is Short-term and Long-term versions depending on the type of mutual funds and the investment holding period.

DDT is a tax on distributed profits. This is paid by the mutual fund companies directly to the government before distributing dividends to the investors. Since the DDT is paid upfront, dividends received is tax-free in the hands of the investor. Meanwhile, Capital Gains Tax is a tax on any gains an individual makes from the sale of mutual funds and it is paid by the investor.

Equity-Based Mutual Funds

Mutual funds that invest predominantly in stocks or other equity-linked instruments fall in this category. If a mutual fund has more than 65% equity in its portfolio, it is treated as an equity fund from a taxation perspective.

Dividend Distribution Tax (DDT)

According to the latest budget announced on 1 Feb 2018, a DDT of 10% on equity mutual funds has been proposed.

Capital Gains Tax

· Short Term: Redemptions in equity mutual funds within 12 months from investing will attract short-term capital gains tax. Gains on equity funds that fall under this category will attract a 15% STCG tax.

· Long term: Redemptions in equity mutual funds within 12 months from investing will attract short-term capital gains tax. Prior to 1 February 2018, tax on long-term capital gains in equity-based mutual funds was ZERO.

However, the 2018 Union Budget proposes that Long Term Capital Gains on equity mutual funds will attract a 10% tax without indexation. It is important to note that gains up to ₹1 lakh in a financial year will not attract LTCG tax. Most of the small investors will not be impacted by the introduction of this tax.

Debt-Based Mutual Funds

Mutual funds that invest predominantly in fixed-income instruments like government and corporate bonds fall in this Debt mutual fund category.

Dividend Distribution Tax (DDT)

All debt mutual funds have a DDT of 28.84%. Hence investing in dividend schemes of debt mutual funds is a bad idea if your annual income is less than ₹10 lakh and you are in 10% or 20% tax slab. Even if you are in the 30% tax slab, the average income tax is likely to be lower than 30%

Capital Gains Tax

· Short Term: Redemption in debt mutual funds within 3 years from the investment date will attract short-term capital gains tax. Gains on debt funds that fall under this category will get added to your taxable income and get taxed at your marginal income tax rate.

· Long Term: Gains from redemption in debt mutual funds qualify as long-term capital gains if they are sold after 3 years of investment date. Profit from these investments will be taxed at 20% irrespective of the tax bracket one belongs to. However, indexation benefits can be claimed on these gains.