More than 51 lakh investors registered new mutual fund SIPs in January 2024, taking the total number of SIP accounts in India to an unprecedented 7.92 crore. Not only the number of mutual fund investors are increasing but the Asset Under Management (AUM) of the industry is also multiplying rapidly.

Amid this exciting trend of growing financialization through mutual funds in India, the need to know how MF income is taxed is also increasingly becoming important for both new and old investors. This article aims to give you a clear idea about mutual fund taxation. But first, let’s understand some basics.

What is Mutual Fund?

Mutual Funds are investment vehicles approved by Securities and Exchange Board of India (SEBI) to pool funds from investors and invest in stock and money markets. The responsibility of investing or managing the funds pooled from investors lie with the fund manager of the Mutual Fund Asset Management Company (AMC).

Investment made by the fund manager is supposed to earn returns for investors from appreciation in underlying stocks and money market instruments over a period of time. The returns from mutual funds may either be in the form of Capital Gain i.e. appreciation in the value of capital invested or in the form of Dividend i.e. distribution of profits by the Mutual Fund AMC into bank accounts of individual investors. Some funds may give both types of returns.

To determine whether a fund is worth investing or not, past track record of post-tax returns could be one of the factors.

Also Read: Is it good or bad to invest in a New Fund Offer (NFO) of mutual fund?

Types of Mutual Funds

Mutual Funds are divided into two groups: Equity-oriented MFs and Debt-oriented MFs.

Equity-oriented funds are schemes having minimum 65% of their assets invested into equity and equity-related instruments. An exception to this is a Fund of Fund (FOF). A FOF shall not be considered an equity-oriented fund even though 100% of its underlying assets are equity and equity related instruments.

Debt-oriented funds consist of all funds other than equity-oriented funds.

Now that you have understood the basics, let’s look at the types of capital gains from mutual funds to understand the taxation part better.

Types of Capital Gains

It is noteworthy that income from mutual funds is not taxed until the units are redeemed. This function is the prime contributor to the compounding effect it has on a person’s portfolio. Depending on the holding period of units, tax is levied on their redemption. It can either be short term or long term. To avoid confusion, we shall only focus on tax laws applicable from 1^st April 2023.

All equity-oriented mutual fund units held for a period of more than 12 months shall be considered for Long Term Capital Gain (LTCG) taxation. Income from mutual fund units held for less than 12 months shall be taxed as Short-Term Capital Gains (STCG). Such distinguishing factor is not applicable to Debt Funds anymore.

Taxation of Dividends

Mutual Fund AMCs deduct 10% tax under Section 194K from the dividend that the Mutual Fund distributes to its investors if the total dividend paid to an investor during the year exceeds Rs 5,000. Such dividend is taxable at the slab rate at which the individual is taxable. This dividend is charged to tax under the head Income from Other Sources in his Income Tax Return.

Taxation of Capital Gains from Mutual Funds

For equity mutual funds, if the gain on redemption of units is short term, such gains shall be taxable at flat 15% regardless of the income tax slab. In case the gain on redemption is long term, you shall be eligible for an exemption of up to Rs 1 lakh and only the balance amount above this threshold shall be taxable. The tax on long term capital gains shall be 10% of the taxable gains.

For Debt Mutual Funds, the gains shall be taxed at the slab rate applicable to the individual.

But what if you have losses under the head Capital Gains?

If you have losses from the head ‘Income from Capital Gains’, they can be adjusted only against profits under this head of income. Losses under this head cannot be set off against profits/gains under any other head of income.

Hence if you have short term capital loss, it can be adjusted either from short term capital gains or long-term capital gains. But if you have long term capital loss in your income statement, it shall only be set off against long term capital gains.

Such losses can be carried forward for a maximum of eight Assessment Years. Filing of income tax return before the due date is mandatory to carry forward losses.

Disclaimer: The above content is for informational purposes only. Please consult a SEBI-registered investor advisor before investing in mutual funds.