Important Keyword: Income from trading, Income Tax, Mutual Funds.
Table of Contents
Income Tax on Mutual Funds
Mutual funds offer a simple and relatively low-risk investment strategy by pooling funds from multiple investors and managing them professionally. They provide diversification, accessibility, and cost-effectiveness, catering to a variety of investment objectives and being regulated for convenience. However, it's important to understand that when redeeming such investments, there is a tax implication in terms of Capital Gains and Losses, given that mutual fund holdings are considered capital assets.
What are Mutual Funds in India?
Mutual funds encompass investment instruments where investors acquire units tied to the performance of assets within the fund's portfolio. Available in different types like equity, debt, and hybrid funds, they cater to a wide range of investment objectives and risk appetites. Investors select funds according to their financial goals, risk tolerance, and investment horizon.
Moreover, Systematic Investment Plans (SIPs) facilitate regular contributions, fostering disciplined and systematic investing. This method empowers individuals to harmonize their investments with their specific financial plans and preferences.
Types of mutual fund
Equity Mutual Funds: These funds invest primarily in equity instruments, with more than 65% of their portfolio allocated to equities. They include various types such as large-cap funds, mid-cap funds, small-cap funds, ELSS (Equity Linked Savings Schemes), Index funds, Arbitrage funds, and others.
Debt Mutual Funds Debt-oriented Mutual Fund primarily invest in fixed-income securities like bonds, treasury bills, and other debt instruments. Examples of debt mutual funds include liquid funds, short-term funds, income funds, hybrid funds, and fund of funds (FOF).
Floater Mutual Fund: These funds allocate a minimum of 65% of their assets to floating-rate instruments, which adjust their interest rates periodically based on prevailing market conditions.
Hybrid Mutual Funds: Also known as balanced funds, these funds invest in a combination of equities and debt instruments. They aim to strike a balance between risk and return, making them suitable for investors seeking diversification. Hybrid funds offer a mix of equity and debt exposure within a single portfolio.
Tax on Capital Gains from Mutual Funds
Capital gains arise when mutual fund units are sold at a profit. The taxation of capital gains depends on whether the gains are short-term or long-term, which is determined by the holding period of the investment.
A. Equity Mutual Funds
i. Short-Term Capital Gains (STCG)
- Applicable when units are held for 12 months or less.
- As per amendments applicable from July 2024, the tax rate on STCG has been increased from 15% to 20%.
- Surcharge and cess are applicable as per the investor’s total income.
ii. Long-Term Capital Gains (LTCG)
- Applicable when units are held for more than 12 months.
- LTCG up to ₹1.25 lakh per financial year is exempt from tax.
- Gains exceeding ₹1.25 lakh are taxed at 12.5%, up from 10% earlier.
- No indexation benefit is allowed on equity mutual funds.
- The LTCG tax rate remains flat and independent of the investor’s tax slab.
B. Non-Equity (Debt, Gold, FoFs) Mutual Funds
i. Capital Gains on Investments Made Before April 1, 2023
- Short-Term Capital Gains (held for 36 months or less): Taxed as per the investor’s income tax slab rate.
- Long-Term Capital Gains (held for more than 36 months): Taxed at 20% with indexation benefit.
ii. Capital Gains on Investments Made On or After April 1, 2023
- All gains, regardless of holding period, are taxed as short-term capital gains, i.e., taxed at the investor’s applicable slab rate.
- Indexation benefit has been removed.
- This applies to debt funds, international funds, gold ETFs, and other non-equity funds.
iii. Post-July 2024 Update: Modified LTCG Treatment for Some Funds
- A new provision has been introduced under which non-equity listed funds held for more than 24 months may qualify for LTCG taxation at 12.5% without indexation, instead of slab rates.
- This includes some international equity FoFs and commodity funds.
- This change offers some relief to investors affected by the withdrawal of indexation.
Dividend Income from Mutual Fund
Earlier, mutual funds used to pay Dividend Distribution Tax (DDT) before distributing dividends. However, from April 1, 2020, DDT has been abolished, and dividends are now taxed in the hands of investors.
Key Points on Dividend Taxation:
- Dividends are added to the total income of the investor and taxed at the applicable slab rate.
- There is no separate tax rate or exemption for mutual fund dividends.
- Mutual fund houses are required to deduct TDS (Tax Deducted at Source) at:
- 10% if the dividend exceeds ₹5,000 in a financial year (raised to ₹10,000 for FY 2025–26).
- 20% for Non-Resident Indians (NRIs), subject to benefit under Double Taxation Avoidance Agreements (DTAAs).
Investors who receive dividend income from mutual fund need to report this income under the "Income From Other Sources" category when filing their income tax returns. This income is taxable at slab rates. Moreover, when Mutual Fund Schemes distribute dividends to investors, the Asset Management Company (AMC) is obligated to deduct TDS at a rate of 10% under section 194K. However, if the dividend amount does not exceed INR 5,000, TDS is not applicable. Understanding these tax implications can help investors accurately report their income and fulfill their tax obligations.
ITR Form, Due Date, and Tax Audit Applicability
For traders with income from the sale of mutual fund, filing the ITR-2 form is essential, as it specifically caters to Capital Gains Income. The due date for filing varies depending on whether Tax Audit applies:
- For Traders without Tax Audit Requirement:
- Due Date: 31st July
- Tax Audit Not Applicable: Since income from the sale of mutual funds is considered Capital Gains, tax audit requirements do not apply. Traders should ensure timely filing of their ITR-2 forms by the specified due date.
- For Traders with Tax Audit Requirement:
- Due Date: 31st October
- Tax Audit Applicable: In cases where tax audit is necessary, traders have until 31st October to file their ITR-2 forms. However, since income from mutual funds falls under Capital Gains, tax audit requirements typically do not apply to this category of income.
Carry Forward Loss for Mutual Fund Investors
In the example provided, Mr. Vijay, a salaried individual, engaged in mutual fund trading during FY 2021-22. Here's a breakdown of his total income and tax liability:
- Salary Income: INR 8,70,000
- Capital Gains/Losses:
- Short Term Capital Loss (STCL): INR 30,000 (From Debt Mutual Funds)
- Long Term Capital Gain (LTCG): INR 2,50,000 (From Equity Mutual Funds)
- Dividend Income: INR 50,000
Total Income: Salary Income: INR 8,70,000 Add: Long Term Capital Gain (LTCG): INR 2,50,000 Add: Dividend Income: INR 50,000 Total Income: INR 11,70,000
Tax Liability Calculation:
- Short Term Capital Loss (STCL) Adjustment:
- STCL can be set off against both STCG and LTCG.
- STCL: INR 30,000
- Remaining STCL carried forward: INR 0
- Net Capital Gain:
- LTCG (after STCL adjustment): INR 2,50,000 - INR 30,000 = INR 2,20,000
- Tax on Capital Gains:
- LTCG Tax Rate: 20%
- LTCG Tax Amount: 20% of INR 2,20,000 = INR 44,000
- Total Tax Liability:
- Tax on Salary Income: As per applicable slab rates on INR 8,70,000
- Tax on Capital Gains (LTCG): INR 44,000
Vijay needs to file his ITR-2 for FY 2021-22, ensuring that he accurately reports his total income and capital gains, and calculates his tax liability accordingly.
| Particulars | Amount (INR) | Amount (INR) |
| Salary Income | 8,70,000 | |
| Capital Gains | ||
| Short Term Capital Loss | (30,000) | |
| Long Term Capital Gain | 2,50,000 | |
| Less: Exemption u/s 112A | (1,00,000) | |
| Taxable Long Term Capital Gain | 1,50,000 | |
| Total Capital Gains after set-off of losses (taxed @10%) | 1,20,000 | |
| Income from Other Sources | ||
| Dividend Income | 50,000 | |
| Total Taxable Income | 10,40,000 | |
| Tax at slab rate | 96,500 | |
| Tax at special rate | 12,000 | |
| Total Income Tax | 1,08,500 | |
| Health & Education Cess @4% | 4,340 | |
| Total Tax Liability | 1,12,840 |
Important Tips for Tax Planning
- Time your redemptions to take advantage of lower LTCG rates.
- Use the ₹1 lakh LTCG exemption in equity funds strategically every year.
- Prefer growth options over dividend options in higher tax slabs.
- For debt funds, investments made before April 1, 2023, can still benefit from indexation and 20% LTCG – avoid premature redemptions.
- Maintain documentation and capital gains statements for at least 6 years for tax audits or assessments.
Frequently Asked Questions
1: I sold equity mutual funds after 14 months and earned ₹1.8 lakh in gains. Will I be taxed?
Answer: Yes. Since the holding period is over 12 months, this is Long-Term Capital Gain (LTCG). The first ₹1.25 lakh is exempt (as per rules from July 2024), and the remaining ₹55,000 is taxed at 12.5%.
2: I bought debt mutual funds in 2022 and sold them in 2024. How will they be taxed?
Answer: As the investment was made before April 1, 2023, and held over 36 months, the gain qualifies as long-term and is taxed at 20% with indexation.
3: I invested in a gold mutual fund in May 2023 and sold it after a year. Is it short-term or long-term?
Answer: Since the investment was made after April 1, 2023, all gains are treated as short-term—even if held for more than a year—and taxed at your income tax slab rate. No indexation benefit applies.
4: My mutual fund dividend was ₹12,000 this year. How will it be taxed?
Answer: Dividends are taxed at your slab rate. Also, since the dividend exceeds ₹10,000 (limit raised for FY 2025–26), TDS at 10% will be deducted by the fund house.
5: I made a ₹40,000 short-term capital loss on debt funds. Can I set it off against gains?
Answer: Yes. Short-term capital loss (STCL) can be set off against both short-term and long-term capital gains. You can also carry it forward for 8 years if not fully set off.
6: I earned salary income and sold mutual funds. Which ITR form should I file?
Answer: Use ITR-2, as it is the correct form for individuals with capital gains income from mutual funds. If no tax audit is applicable, the due date is 31st July.
7: I started SIPs in equity mutual funds 10 months ago. If I redeem now, how will I be taxed?
Answer: Since units are held for less than 12 months, this is Short-Term Capital Gain (STCG). From July 2024, STCG on equity funds is taxed at 20%, plus cess/surcharge.
8: I am an NRI and received ₹8,000 as mutual fund dividends. Will TDS apply?
Answer: Yes. For Non-Resident Indians, TDS at 20% applies on dividend income, even if the amount is below ₹10,000. You may claim relief under DTAA, if applicable.
Read More: Section 54: Capital Gains Exemption on Sale of House Property
Web Stories: Section 54: Capital Gains Exemption on Sale of House Property
Official Income Tax Return filing website: https://incometaxindia.gov.in/
