Investor can derive two types of income from Mutual Fund :
2.Capital Gain /loss
Both income have different tax implications and depends on whether mutual fund is equity mutual fund or debt mutual fund.
First, let me explain the types of mutual funds which commonly adopted by investors :
- Equity (stock)
- Fixed income (bonds)
- Money market (short term debt)
- Both stock and bond (balanced /hybrid funds)
1. Equity Funds
These have higher potential of growth and more potential volatility in value. These funds invest mainly in stocks.
Equity funds are divided in three categories, on the basis of market value of companies, fund is investing in.
- Large cap fund = company having market value of $10 billion or higher.
- Mid cap fund = company having market value higher than $2 billion but less than $10 billion.
- Small cap fund = company having market value worth $300 million to $2 billion.
2.Fixed income funds
Unlike equity funds, these funds invest in government and corporate debt.
Investors gets paid @fixed amount on their initial investment.
3.Money market funds
These funds invest in high quality short term debt from government, banks and corporations.
Its a combination of equity and fixed income fund with a ratio of 60% in stock and 40% in bonds.
Taxation of Mutual Fund
- The tax amount will defer as per the holding period of mutual fund. This holding period is either short term or long term.
- Short term benefit will be known as Short term capital gain or loss (STCG).
- Long term benefit will be known as Long term capital gain or loss (LTCG).
- For equity and equity oriented balanced funds, less than 12 months is short term and 12 month or more will be long term.
- For debt and debt oriented balanced fund, less than 36 month is short term and 36 month or more will be long term.
1. Tax saving equity funds
These are commonly known as ELSS (Equity Linked Saving Scheme).
Investor get benefit under section 80C with respect to their investment upto ₹1,50,000/-
These funds have lock in period of 3 years. Thus the benefit automatically becomes LTCG and taxable only if LTCG (i.e. Your benefit) is more than ₹1,00,000/-.
For example, if the gain or say benefit after sale is ₹1,50,000/- then only ₹50,000 will be taxable as LTCG.
LTCG will be taxable @10% without indexation.
Indexation is the process to take inflation into consideration from the time of buying investment till the time you sell investment.
Investor don’t get indexation benefit in short term holding.
2.Non-tax saving equity funds
They don’t get any benefit of deduction under section 80C.
But investor, here too will pay tax only if LTCG is above ₹1,00,000/-
If your holding is for short term, STCG will be taxable @15% and if your holding is for long term, LTCG will be taxable @10% without indexation.
3.Non equity i.e.Debt Funds
If the investor hold them for short term, gain will be taxable at the income tax slab applicable to investor.
If the investor hold them for long term, LTCG will be taxable @20% after indexation.
Remember, long term here is 36 months or more.
These are equity oriented hybrid funds
They invest minimum 65% of their asset in equity.
Tax treatment of balanced fund would be same as non-tax saving equity funds.
Some pointers to consider :
- The popular way to invest in mutual fund is through SIP (Systematic Investment Plan). This could be on daily, weekly, monthly or quarterly basis.
- Each SIP is considered as new investment and gain will be calculated accordingly.
- Payment of dividend distribution tax (DDT) is the responsibility of fund House.
- DDT is paid by fund house before paying dividend to investors. The burden is not supposed to be passed on to investor.
- Other than LTCG tax, there is an STT (Securities Transaction tax) @0.001% on every purchase and sale of equity or balanced fund only.It’s Not for debt funds.
- First decide your purpose, whether you are investing for new house or car or wedding or retirement. Accordingly, decide the period of your investment.
- If you need a regular income, you can go for dividend schemes, if not, go for growth schemes.
- As per term and your risk bearing capacity, pick debt or equity fund.
- If you are young and investing not for any specific purpose and just to keep some money aside, always go for equity funds.