Planning to save smart with mutual funds? Know these taxation rules

Mutual fund tax rules: Are you an investor who parks money in mutual funds? According to experts, you could potentially save a substantial amount through savvy tax planning. By understanding the ins and outs of mutual fund taxation, you can optimise your investment strategy and minimise tax liabilities.

Taxes associated with dividends, redemptions, and capital gains can impact an investor's financial outcomes, necessitating careful consideration alongside other investment factors. Acquiring a thorough understanding of mutual fund taxation empowers investors to strategically plan their investments, minimising tax liabilities and optimising returns.

Factors in mutual fund taxation

Several key factors influence mutual fund taxation, including fund types, capital gains, dividends, and holding periods. Mutual funds are categorised into equity-oriented and debt-oriented funds for taxation purposes, with each category subject to distinct tax regulations. Capital gains, representing profits from selling assets at a higher price than their purchase cost, are taxed upon the redemption of mutual fund units. Conversely, dividends, which are distributions of profits to investors, are taxed based on the investor's income tax bracket.

Diverse tax rules: Dividends & Gains

Taxation rules for dividends and capital gains vary depending on factors such as the holding period and fund type. Following the repeal of the Dividend Distribution Tax (DDT) by the Finance Act of 2020, investors are now liable for taxes on dividend income according to their income tax slab. 

Additionally, dividends exceeding Rs 5,000 per annum are subject to a 10 per cent Tax Deducted at Source (TDS). Capital gains from equity funds are taxed at a flat rate of 15 per cent for short-term gains and enjoy an exemption of up to Rs 1 lakh per annum for long-term gains. 

Any long-term gains exceeding this threshold are taxed at 10 per cent, without indexation benefits. In contrast, capital gains from debt funds are taxed at slab rates for short-term gains and at 20 per cent with indexation benefits for long-term gains.

Hybrid fund tax treatment

Hybrid funds, characterised by either an equity or debt focus, adhere to tax regulations based on their primary focus. The sale of equity fund units incurs a 0.001 per cent Securities Transaction Tax (STT), while STT is not applicable to debt fund units.

A clear understanding of mutual fund taxation enables investors to make informed decisions, effectively manage tax liabilities, and optimise returns. According to experts, strategic tax planning, whether through long-term investments or tax-saver funds, can further minimise tax obligations and enhance the efficiency of mutual fund investments, regardless of the investment mode, be it lump sum or Systematic Investment Plan (SIP).