Mutual Fund Taxation

Financial Advice

| Written by IME's Investor Desk on 05-Apr-21

A mutual fund is structured as a pass-through vehicle. The fund, in the form of a trust, itself is exempted from any taxation. Therefore, all the tax expenses are calculated at the investor level.

While Mutual Funds are structured as a pass-through vehicle, investors are only taxed on redemption of mutual fund units. They are not taxed on transactions that take place at the trust level. This is what gives Mutual Funds, a considerable tax advantage over direct investments or other vehicles such as PMS & AIF's.

MF Categories Classified as Equity or Debt

Mutual funds are classified as equity, if they maintain a minimum allocation of 65% in equity shares. It is important to note, that arbitrage is also classified as equity. This is how dynamic asset allocation & equity savings schemes that use arbitrage to replicate debt, are also classified as equity.

Funds classified as Equity: Equity funds, Aggressive Hybrid, Dynamic Asset Allocation, Equity Savings Scheme, Arbitrage
Funds classified as Debt (Specified Mutual Funds): Debt funds, Conservative Hybrid
Fund Classified as Other Mutual Funds: FOFs, Gold, Silver

Equity Mutual Fund Taxation

Equity Mutual Funds are taxed based on the holding period of the units.

Short-term Capital Gains Tax (less than 12 month holdings): 20%
Long-term Capital Gains Tax (more than 12 months holdings): 12.5%

Note:

1.25 lakh p.a. equity gains exemption: long-term capital gains of upto 1.25 lakh p.a. are exempted from LT equity taxation
Grandfathering: LT equity capital gains tax was brought into effect in the 2018 Budget. This included a 'grandfathering clause' to avoid the retrospective effect of the new tax. Any capital gains earned till 31-Jan-2018 are not taxable. For investments prior to 31-Jan-18, the cost of purchase for tax purposes is the higher of cost price & the price as of 31-Jan-18.

Specified Mutual Fund (Debt) Taxation

For units purchased after 31-Mar-2023, any capital gains on redemption will be added to the investors income and taxed based on their applicable tax slab.

Dividend Income

Dividend income earned on MF units, are taxed at the hand of the investor based on his income tax-slab. Due to this, any investor that is in the top-tax slab, should avoid the dividend MF option.