A lesson in mutual fund investment

Mutual funds are one of the most preferred vehicles of investment for the kind of appreciation and ease of investing it offers. Exposure to any kind of financial instrument like equities, debt or any money market instrument is possible through Mutual Funds. Before deciding on investing in MFs, ponder upon the tax provisions for the particular category and see if it suits your portfolio.

Tax implications on mutual funds arise on two occasions: Dividend paid out by mutual fund and gains arising from sale of mutual funds.

Equity Mutual Funds

Equity mutual funds are found in the portfolio of most investors. Within the umbrella of equity mutual funds, there are many sub categories like the Large-cap fund, Mid-cap fund, Blue Chip funds, Small-cap funds, etc. An equity scheme is one which holds at least 65 per cent of its exposure to equity. To avail tax benefits the equity holdings cannot fall below this level. However, the tax treatment remains same for investors of all categories of equity mutual funds.

Dividend payout: Dividend received by a mutual fund is not taxed in the hands of an investor or the mutual fund company.

Short-term gains: When mutual fund units are sold before the completion of one year, the gain made is called as short-term capital gain. This is taxed at the rate of 15 per cent irrespective of the income tax slab that you fall under. A 3 per cent cess is also levied bringing the tax rate to 15.45 per cent.

Long-term gains (LTCG): If the units in equity mutual funds are sold after a holding period of one year, the gain made is Long-term capital gain. LTCG in case of equity mutual fund is exempt from tax.

Debt Mutual Funds

The tax structure for debt mutual funds varies quite a bit from the equity mutual funds.

Dividend payout: The dividend income is not taxable in the hands of the unit holder. However, the mutual fund house needs to pay a dividend distribution tax of 13.519 per cent (12.5 per cent + 5 per cent surcharge + 3 per cent cess) before payment of dividend to its investors. Though this tax is to be paid by the mutual fund, it is passed over to the investor.

Short-term capital gains: The holding criteria for debt mutual fund remain same as in equity-oriented funds. Any gain realised before the end of one year is added to the income of the investor and taxed at appropriate rate. For eg: Anita sold her debt mutual fund before the end of the year and made a short term gain of Rs 50,000 and she falls in the 20 per cent income tax bracket. So her gain will be taxed at a rate of 20.6 per cent (inclusive of cess).

Long-term capital gains: Any gain realised after one year in case of debt mutual fund falls under the category of long-term capital gains. But unlike equity mutual funds, long-term capital gains from debt mutual funds are taxed at 10 per cent without indexation or 20 per cent with indexation.

Money Market Mutual Funds

These funds invest in very short tenured debt instruments ranging from one day to one year. They offer instant liquidity to its investors and often used to park funds, which are needed after a very short period. The tax treatment for investors remain same as in debt mutual funds.

Gold Mutual Funds: 

The taxation rules remain the same as debt MFs for gold mutual funds.

It is very important to understand the effect of each category of mutual fund before investing so that you can maximize your post tax returns.

Source: http://www.indianexpress.com/news/a-lesson-in-mutual-fund-investment/1049341/0