Taxation of income from shares and mutual fund in India

As we all are aware that your income from salary, rent and income from business is eligible for tax. However what about the income which you earn from shares and mutual funds? Well they are also taxable. Many people are not aware about such implication, hence in this article we have tried to explain you about the taxability of income from shares and mutual funds.

How Do You Earn Returns in Mutual Funds?

Two forms of returns are offered by Mutual Funds;

• Dividends and
• Capital gains.

Dividends are given out of the profits of the company. When the companies have a surplus, they may decide to share the same with investors as dividends. Investors get dividends proportional to the number of mutual fund units held by them.

A capital gain is a profit realized by investors when the security is sold, i.e., if the selling price of the stake held by them is greater than the price at which they acquired them.

The crux is Capital gains are realized due to the appreciation in the price of the mutual fund or share’s units. The dividends and capital gains earned are taxable in the hands of investors of mutual funds.

Taxation of Mutual Funds

Mutual funds are one of the most trending investment options these days as they help you accomplish your financial goals.

Mutual funds can also be tax-efficient instruments. Investing in fixed deposits these days is not a good idea. Usually, if you fall under the highest income tax bracket, you should be reluctant to invest in an FD, as the interest is taxed by getting added to your taxable income at slab rates. In this scenario, mutual funds score better. When you invest in a mutual fund, you get an advantage as experts manage your money, and you get tax-efficient returns.

Taxation of Dividends Offered by Mutual Funds

After Union Budget 2020, dividends given by any mutual fund scheme are now taxed ordinarily. The’ dividends are added to the Investor’s taxable income and taxed at their income tax slab rates.

Earlier, dividends were exempt in the hands of investors as the companies had to pay dividend distribution tax (DDT) before distributing their profits with investors in the form of dividends. Hence, yes, you read it right dividends are now taxable.

Taxation of Capital Gains Offered by Mutual Funds.

The tax rate of capital gains of mutual funds depends on the period for which you hold that particular mutual fund and its type. The holding period is the duration for which an investor held the mutual fund units. In simple words, the holding period is the time between the purchase and sale of mutual fund units. Capital gains realized on selling units of mutual funds are categorized as follows:

We gave this explanation because the short-term and long-term capital gains of mutual funds are taxed at different rates. Now let us understand the contents of the above table;

Taxation of Capital Gains of Equity Funds

Equity funds are mutual funds in which portfolio equity exposure exceeds 65%.

As stated above, you receive short-term capital gains on redeeming your equity fund units within a holding period of one year. These gains are taxed at a flat rate of 15%, irrespective of your income tax bracket, i.e., the slab rate you are falling.

You get long-term capital gains on selling your equity fund units after holding for one year or more. These capital gains are exempt up to Rs 1 lakh in a year. Any long-term capital gains exceeding this limit attract tax at the rate of 10%, and also, you cannot avail any benefit of indexation on the same.

Taxation of Capital Gains When Invested Through SIPs

• Systematic investment plans (SIPs) are ways of investing in mutual funds. They are designed so that investors can invest a small amount periodically in a mutual fund scheme. Investors are offered the opportunity to choose the recurrence of their investment. It can be weekly, monthly, quarterly, bi-annually, or annually.
• You purchase a certain number of mutual fund units through every SIP installment. The redemption of these units is processed on a first-in-first-out basis. For example, suppose you invest in an equity fund through a SIP for one year, and you decide to redeem your entire investment after 13 months.
• In this case, the units acquired first through the SIP are held for the long-term (over one year), and you realize long-term capital gains on these units. If the long-term capital gains are less than Rs 1 lakh, you don’t have to pay any tax.
• However, you make short-term capital gains on the units purchased through the SIPs from the second month onwards. These gains are taxed at a flat rate of 15%, irrespective of your income tax slab. You will have to pay the applicable cess and surcharge on it.

Securities Transaction Tax (STT)

Apart from the tax on dividends and capital gains, another tax is called the Securities Transaction Tax (STT). An STT of 0.001% is levied by the government (Ministry of Finance) when deciding to buy or sell mutual fund units of an equity fund or a hybrid equity-oriented fund. On the other hand, there is no STT on the sale of debt fund units.

Conclusion

The longer you hold on to your mutual fund units, the more tax-efficient they become. This is because the tax on long-term capital gains is comparatively lower than the tax on short-term gains.

A good investment advisor can help you maximize returns and minimize risks.