How are Flexi Cap Funds Taxed?

Mutual investments are more than evaluating performances to choose the right scheme. Taxation on such funds is crucial, as it influences the final return on investment. Investors can lose on their overall profits on a high-profit generating scheme like flexi cap mutual funds if taxation isn’t taken into consideration when planning the investment and estimating the returns. The tax rules have been laid out for flexi cap fund returns. And while you plan to invest or are simply trying to learn more about the investment opportunities, it’s important to get a comprehensive idea of taxation.

What are Flexi Cap Funds?

Note: In September 2020, SEBI made it compulsory for multi-cap funds to invest 25%, at the least, in large-, mid-, and small-cap companies. This new regulation prevented managers from focusing on large-cap stocks in comparison to the freedom they had before. By November 2020, SEBI introduced a new investment category, the flexi cap funds, to provide managers more flexibility for asset allocation.

What do Flexi-cap funds mean?

A flexi cap mutual fund is basically an open-ended scheme. It invests across companies with different market capitalisations. This type of fund, while providing more flexibility, must invest 65% of total assets in equities. Fund managers can freely allocate the remaining funds (35%) in debt or other categories. This flexibility will allow them to address the changing market conditions and adjust investment strategies.

Flexi Cap Fund Taxation Rules

Considering the equity-oriented nature of flexi-cap funds, they are treated the same as equity funds under the taxation rules of India. Different rules are applicable to long-term and short-term capital gains.

Short-Term Capital Gains (STCG)

If investment in a flexi cap mutual fund is held for less than 12 months, the profit generated will be considered as short-term gains. The tax rate of short-term capital gains is 15%, plus any cess or surcharge as applicable.

Suppose investors earn INR 50,000 in profit when redeeming their units within 10 months. The tax would be - 15% of that INR 50,000 + cess/surcharge.

Long-Term Capital Gains (LTCG)

Profits from funds held for more than 12 months are long-term capital gains. Such gains are tax-exempt up to INR 1 lakh. Any profit over this threshold will be taxed at 10% without any indexation benefit.

Suppose a fund has generated INR 1.5 lakhs in long-term capital gains. After accounting for the tax-free rule up to INR 1 lakh, the remaining INR 50,000 will be taxed at 10%.

This is why investments in flexi-cap funds tend to perform better when held long-term. With this taxation rule, an investor can maximise the flexi cap fund return and meet their long-term capital-building goals.

Dividend Distribution Tax (DDT) / IDCW Taxation

IDCW (Income Distribution cum Capital Withdrawal) is crucial for those who have opted for a dividend plan. Dividends are taxed as per the income and individual tax slab rates of investors.

The higher the tax bracket, the greater the tax rate on the flexi cap mutual fund dividends. Naturally, investors from lower tax brackets will lose less in taxation.

Tax-Saving Strategies for Flexi Cap Investors

Taxation can reduce the overall effectiveness of flexi-cap funds. However, investors can follow certain strategies to improve post-tax returns:

• Hold for Long-Term: Long-term capital gains up to INR 1 lakh are free from tax. Also, the applicable tax rate is lower than that for short-term capital gains. Holding funds for more than 12 months can be more tax-efficient.

• Go for SIPs: SIPs help investors to benefit from different market cycles and average purchasing costs, which improve potential returns.

• Choose Growth Option over IDCW: For investors looking at wealth creation, choosing the growth option ensures reinvestment of profits and minimises tax outflow compared to dividends taxed at slab rates.

• Strategic Plan Redemptions: Redeeming in a staggered manner can help keep annual long-term gains within the ₹1 lakh exemption limit, thereby reducing taxable income.

Conclusion

Be it the 10% tax rate on long-term capital gains, the 15% rate on short-term capital gains, or the taxation of dividends as per tax slab rates, a significant amount from the flexi cap fund returns can go into fulfilling tax responsibilities. This is why it is of utmost importance to understand the tax structure around flexi cap funds, and consider when estimating final profits. This will help with more accurate and informed financial planning. Flexi-cap funds' meaning goes beyond diversification. These funds offer the flexibility to shift between different market segments and benefit from available opportunities .

Disclaimers:

The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision.

Investors are advised to consult their Tax Consultant or Financial Advisor to determine tax benefits applicable to them.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.