Income from the mutual fund can be categorized into two streams: Dividends and appreciation when realized are taxed as capital gains.
The mutual fund schemes can be divided into two categories for tax purposes. In the first category, fall all equity-oriented schemes, and the rest of the schemes fall in the second category.
Any mutual fund scheme which keeps a minimum of 65% of their corpus invested in the Indian companies which are listed in India fall under equity-oriented schemes. Likewise, any fund which invests a minimum of 90% of its corpus in an ETF which in turn invests a minimum of 90% of its corpus in these companies is also treated like equity-oriented schemes.
One of the popular schemes amongst taxpayers ELSS eligible for deduction under Section 80C falls under this category. By this definition, all aggressive hybrid funds which maintain their minimum 65% investment in such companies are treated as equity-oriented schemes. All other schemes like conservative hybrid schemes, debt funds, gold ETF, gold funds, and international funds fall in the second category.
Any profit realized on an equity-oriented scheme sold/redeemed after 12 months is treated as long-term capital gains and taxed at a flat rate of 10% after an initial exemption of one lakhs without indexation. The profits on such schemes realized within 12 months are treated as short-term capital gains and are taxed at a flat rate of 15%.
In case investments in such schemes were made before 31st January 2018 the profits accrued till 31st January 2018 are grandfathered and the NAV as of 31st January 2018 is to be taken as your cost for computing long-term capital gains.
For the second category, the profits are treated as long-term capital gains if sold/redeemed after 36 months. Long-term capital gains are taxed at 20% after applying indexation on your cost of acquisition. Any profits made before 36 months are treated as short-term capital gains and are added to your regular income and taxed at the slab rate applicable to you.
Set-off of losses of capital gains on mutual funds
All short-term capital gains and long-term capital gains are aggregated separately. Short-term loss can be adjusted against long-term gains but the long-term loss cannot be adjusted against short-term gains. Loss under the head capital gains cannot be adjusted against income under any other head. Any capital loss not adjusted during the current year is allowed to be carried forward for the next 8 years for set off in subsequent years.
How dividends from a mutual fund are taxed
Dividends are taxed like your regular income under the head income from other sources. The mutual fund house deducts tax at 10% on dividends, in case the aggregate dividends likely to exceed five thousand in a year for all the schemes of the same fund house. If you have borrowed to invest in mutual funds, you can claim interest up to 20% of the aggregate dividend amount against such income.
Taxation rules for Non Residents
There is no difference between resident and non-resident for holding period criteria and rates of tax applicable for capital gains but the mutual fund house deducts TDS at the time of redemption on the amount of capital gains. No TDS is required to be made for resident taxpayers.
Non-residents do not enjoy the benefit of basic exemption in respect of all long-term capital gains and short-term capital gains on equity schemes and they have to pay full tax at the flat rate on such capital gains in case their income comprises only such capital gains. Likewise, non-residents are not entitled to avail rebate under Section 87A up to Rs. 12,500/-. This rebate is of tax available to a resident taxpayer with income up to five lakhs against the tax liability of all nature except tax on long-term capital gains on equity schemes.
Tips to manage tax on mutual funds
As long-term capital gains on equity are exempt up to one lakh every year, you can look to book a minimum of 1 lakh long-term capital gain on equity schemes for each of your family members. Even if you wish to continue with the same scheme you can redeem and buy the same scheme on the same day with the same NAV and you have to pay just a small amount as STT and stamp duty.
Moreover, those whose taxable income does not exceed five lakhs in a year can plan their capital gains in such a way that they are able to get tax-free capital gains within the tax rebate of Rs. 12,500/- under Section 87A. Please note that this rebate under Section 87A is not available for long-term capital gains on equity schemes.
In case you are planning to buy a residential house and you do not own more than one house, you can plan your long term capital gains in such a way so as to avail exemption under Section 54F for long term capital gains on your mutual fund investments in case you are sitting on huge unrealized long term capital gains.
No tax deductions are available under Chapter VIA against all the long-term capital gains and short-term capital gains from equity schemes. This includes various sections like Section 80 C covering deductions for LIP, PF, PPF, School Fee, Repayment of home loan, ELSS, etc., Section 80 CCD covering NPS, Section 80 D for Mediclaim, Section 80 G for donation, etc. No in case you do not have sufficient income on which tax is payable at your regular slab rates, do not invest in products that are eligible for this deduction