Investing in mutual funds can be tricky, due to multiple nuances involved in investments and tax structuring questions. Through this article, we look at certain such taxation aspects relating to equity oriented mutual funds.
What are equity mutual funds?
Simply stated, equity oriented mutual funds are funds which invest principally in stocks. Equity funds could be good investment vehicles for novice investors who do not possess the expertise to directly invest in stocks or do not have considerable financial capital or risk appetite to invest. There are various unique characteristics of these funds, such as-
Risk reduction- Individual risks are absorbed by portfolios due to diversification in investments; hence, market fluctuations do not materially affect the investments. A more diversified fund indirectly reduces the negative effects of individual stock’s adverse prices.
Small capital required- Equity investments do not require huge capital investments. They are therefore desirable for small investors looking to invest their savings,
How are equity mutual funds taxed?
Mutual funds are tax-efficient investments and are often preferred as tax planning mechanisms. Generally, a mutual fund can generate two kinds of returns- (i) Dividends and (ii) Capital gains. Taxation of the dividend is done by a levy of a dividend distribution tax (also called "DDT"), which are deducted at source.
Dividends from equity oriented mutual funds are tax-free in the hands of investors. But dividends are paid after deducting a dividend distribution tax (DDT) of 11.648% (including surcharge and cess), which ultimately reduces the in-hand return for investors.
Further, the sale/ redemption of mutual funds can result in tax implications as well. These may arise in the form of Short-Term Capital Gains (called as "STCGs") and Long-Term Capital Gains (called as "LTCGs"). For equity oriented mutual funds, the period of holding for LTCGs is 12 months and above.
Short-term capital gains from equity orientated funds remained unchanged and are taxed at the rate of 15% plus surcharges & cess.
Post Budget 2018, LTCGs on equity oriented mutual funds earlier tax free would be taxed at the rate of 10% (plus applicable surcharge and cess) above a gain of INR 1 lacs per annum without the benefit of indexation. Furthermore, to provide relief to existing investors, amount of capital gains made up to 31 Jan 2018 are exempted. The amount of Gains made after this cut-off date will be taxed i.e. gains until January 31, 2018 are ‘grandfathered’.
Even though now there is a LTCG tax, on equity mutual funds, with their low expenses, shorter lock in period, better and transparent portfolio management they still aim to provide potential higher tax adjusted returns.
Investors are advised to consult their tax advisors for their individual tax implications.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.