Mutual funds offer investors returns in two forms; dividends and capital gains.
As per the amendments made in the Union Budget 2020, dividends offered by any mutual fund scheme are taxed in the classical manner. That is, dividends received by investors are added to their taxable income and taxed at their respective income tax slab rates.
The taxation rate of capital gains of mutual funds depends on the holding period and type of mutual fund. The holding period is the duration for which the mutual fund units were held by an investor. In simple words, the holding period is the time between the date of the purchase and sale of mutual fund units. Capital gains realized on selling units of mutual funds are categorized as follows:
| Fund Type | Short-term capital gains | Long-term capital gains |
|---|---|---|
| Equity Funds | Shorter than 12 months | 12 months and longer |
| Debt Funds | Shorter than 36 months | 36 months and longer |
| Fund Type | Short-term capital gains | Long-term capital gains |
|---|---|---|
| Equity funds | 15% + cess + surcharge | Up to Rs 1 lakh a year is tax-exempt. Any gains above Rs 1 lakh are taxed at 10% + cess + surcharge |
| Debt Funds | Taxed at the investor’s income tax slab rate | 20% + cess + surcharge |
Apart from the tax on dividends and capital gains, there is another tax called the Securities Transaction Tax (STT).An STT of 0.001% is levied by the government (Ministry of Finance) when you decide to buy or sell mutual fund units of an equity fund or a hybrid equity-oriented fund. There is no STT on the sale of debt fund units
The longer you hold on to your mutual fund units, the more tax-efficient they become. The tax on long-term capital gains is comparatively lower than the tax on short-term gains.
