What are the Tax Benefits of Mutual Fund By Devashish Bharti

Dear Professional Colleagues,

Mutual Fund is an Investment Programme funded by Shareholders/Public that trades in diversified holdings and is professionally managed.

According to Wikipedia, A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. These investors may be retail or institutional in nature.

According to Investopedia, A mutual fund is an investment vehicle/option made up of a pool of money collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments, and other assets. Mutual funds are operated by professional money managers, who allocate the fund's investments and attempt to produce capital gains and/or dividend/interest income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.

In Layman Language, a Mutual fund is a type of fund which is collected from Public at Large to provide attractive Earnings at significantly lower Capital Risk through investing the Fund into Capital Market in a diversified manner which is managed by AMC/ARC at a very low cost. An Asset Management Company/Asset Reconstruction Company is usually an NGO established as a Trust, Society or Section 8 Company under Companies Act, 2013 for the benefit of the Society and not to Earn Profit.

A Mutual Fund is mutually beneficial for General Public who have small savings, Companies which are in need of fund, and is also accelerates the Growth of the Country as the AMC/ARCs are Expert in these fields & they manage Large Funds due to which cost reduces & they charge very low amount to provide these services.

Mutual Funds in India are governed by the SEBI (Mutual Fund) Regulations, 1996 as amended from time to time (https://www.sebi.gov.in). SEBI registered Mutual Funds are Listed and available for Trading in the Capital Market segment of the Exchange.

The list of such units listed on the Exchange and available for trading as on date is available at the following URL: www.nseindia.com, www.bseindia.com.

Types of Mutual Fund Scheme on the Basis of Maturity Period:

Open Ended Fund or Scheme - An open-ended scheme of Mutual Fund is one that is available for subscription and repurchase on a continuous basis. These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices which are declared on a daily basis. The key feature of open-end schemes is liquidity.

Close Ended Fund or Scheme - These schemes of Mutual Funds have a fixed maturity period so they are not as liquid as an Open Ended Scheme. However, An Investor can always sell his Units in a Secondary Market. A close-ended scheme has a stipulated maturity period Example, five and seven years.

Income Tax Provisions for Resident Indian w.r.t. Mutual Fund:-

  • The STCG (Short Term Capital Gains) Tax Rate on Equity Oriented Funds (Listed) is 15% for the Assessment Year 2018-19 & 2019-20 if Securities Transaction Tax at the prescribed percentage is paid on such Sale/Transaction.
  • The STCG Tax Rate on Non-Equity funds (or) Debt funds is as per the investor’s income tax slab rate.
  • The LTCG (Long Term Capital Gains) Tax Rate on Equity Oriented Funds (Listed) is NIL till 31-01-2018 (Exemption u/s 10(38) of Income Tax Act, 1961). For Transaction taking place on or after 01-02-2018, there will be an Exemption of 1 Lakh Income. Gain over and above Rs.1 Lakh will be Taxable @10% without Indexation in the hands of Investor/Unitholder. (For Providing Exemption till 31-01-2018, the Fair Market Value of Mutual Fund as on that date will be taken as a base to compute Taxable LTCG).
  • The LTCG Tax Rate on Non-Equity Funds is 20%(with Indexation Benefits).
Income Tax Provisions for Non-Resident Indian (NRI) w.r.t. Mutual Fund:-
  • Other Provisions will be same Except that the LTCG Tax Rate on Non-Equity Funds is 20% (with Indexation) on Listed Securities/Mutual Fund Units and 10% (without Indexation) on Unlisted Securities/Units.
What are Equity-Oriented Mutual Funds?

MF schemes that invest at least 65% of its fund corpus/capital into equity and equity related instruments are known as equity mutual funds. Examples are Large-cap, Mid-cap, Balanced funds (equity oriented), Sector funds etc.

What are Non-Equity Mutual Funds?

MF schemes that hold less than 65% of their portfolio in equities and equity related instruments are known as Non-Equity Funds / Debt funds. Examples are Liquid Mutual funds, Money Market funds, Gold funds, Infrastructure debt funds, Balanced funds (Debt oriented) etc.

Period of Holding & Capital Gains on Mutual Funds:-

Capital gains on Mutual funds could be either Long Term Capital Gains or Short Term Capital Gains, depending on your investment horizon. Set Off and Carry Forward of Loss on Sale of Mutual Fund Units is allowed similarly as to Long Term/Short Term Capital Loss on Other Capital Assets.

Long-Term Capital Gains

If you make a gain/profit on a sale of your investment in an Equity Mutual Fund scheme that you have held for over 1 year, it will be classified as Long Term Capital Gain.

If you make a gain / profit on sale of your investment in a Non-Equity Mutual Fund scheme (or in a Debt Fund) that you have held for over 36 months, it will be classified as Long Term Capital Gain.

Short Term Capital Gains

If your holding in an Equity Mutual Fund scheme is less than 1 year i.e. if you withdraw/sale your mutual fund units before 1 year, after making a profit, then the profit will be considered as Short Term Capital Gain.

If you make a gain / profit on sale of your Debt based Mutual Fund (or other than Equity Oriented schemes) that you have held for less than 36 months, it will be treated as Short Term Capital Gain.

Mutual Funds Taxation Rules on Dividends:-

Dividends on Equity Oriented Mutual Funds

The dividend received in the hands of Unitholder/Investor for an Equity Mutual Fund or where More than 65% of Fund is invested in Equity is Fully Exempt under Section 10(35) of Income Tax Act, 1961. The dividend is also Tax-Free to the mutual fund house (ARC/AMC) under Section 10(34). But, before paying Dividend to Unitholder, the Mutual Fund Houses have to pay DDT/CDT @11.65% to the Government (which will reduce the Income in the hands of Investors and they will not be able to claim Tax Credit for those Dividend Distribution Tax because DDT is different from TDS).

Dividends on Debt Oriented Mutual Funds

The dividend income received by a Debt Fund Unitholder is also Tax-Free under Section 10(35). But, the Mutual Fund Company has to pay a Dividend Distribution Tax/Corporate Dividend Tax @29.12% before distributing this dividend income to its Unitholders and No Tax Credit is allowed in the hands of Unitholders for CDT paid by Mutual Fund Houses.

What is an SIP?

A Systematic Investment Plan (SIP) is an investment vehicle offered by Mutual Funds to Investors, allowing them to invest small amounts periodically instead of lump sums. The frequency of investment is usually weekly, monthly or quarterly. It lets you set aside a fixed sum of money at regular intervals with an objective to generate capital appreciation in the longer run. In SIPs, a fixed amount of money is debited from the investor’s bank account periodically and invested in a specified mutual fund. The investor is allocated a number of units according to the current Net asset value. Every time a sum is invested, more units are added to the investors' account.

The strategy claims to free the investors from speculating in volatile markets by Cost Averaging. As the investor is getting more units when the price is low and less units when the price is high, in the long run, the Average cost Per Unit is supposed to be lower.

SIP claims to encourage disciplined investment. SIPs are flexible, the investors may stop investing a plan anytime or may choose to increase or decrease the investment amount. SIP is usually recommended to retail investors who do not have the resources to pursue the active investment. A recurring payment can be set for SIP using Electronic Clearing Services (ECS). Some mutual funds allow tax benefits under Equity-linked savings schemes. This, however, has a locking period of Three Years.

Note - Surcharge @ 15%, is applicable where the income of Individual/HUF Unitholder exceeds Rs.1 Crore. Also, Surcharge @10% to be levied in case of Individual/ HUF unitholders where the income of such Unitholders exceeds Rs.50 lakhs but does not exceed Rs.1 Cr. Further, Health and Education Cess @ 4% will continue to apply for the aggregate of Tax and Surcharge. As a Resident Indian, there will be No TDS when you sell/redeem your units. You are required to show the income and pay taxes; if any; when you file your Income Tax Returns. However, for a Non-Resident Indian, while the tax laws remain the same for capital gains, TDS will be deducted, at the applicable rates, at the time of Redemption.

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