Important Keyword: Income from trading, Income Tax, Mutual Funds.

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.

Capital Gains on Mutual Funds

To determine the capital gains tax rate on mutual fund, we first need to ascertain the holding period of the asset. The holding period refers to the duration for which an investor holds the mutual fund units before selling them. The holding period is categorized into two main categories:

1. Short-term holding period: If the investor holds the mutual fund units for less than 36 months (3 years), it is considered a short-term holding period.
2. Long-term holding period: If the investor holds the mutual fund units for 36 months (3 years) or more, it is considered a long-term holding period.

The tax treatment for capital gains on mutual fund varies based on the holding period:

1. Short-term capital gains (STCG): If the investor sells the mutual fund units within the short-term holding period, the gains are classified as short-term capital gains. Short-term capital gains are taxed at the applicable slab rates as per the investor’s income tax bracket.
2. Long-term capital gains (LTCG): If the investor sells the mutual fund units after holding them for the long-term period, the gains are classified as long-term capital gains. The tax rate for long-term capital gains on equity mutual funds is 10% (without indexation) for gains exceeding ₹1 lakh in a financial year. However, for debt mutual funds, the LTCG tax rate is 20% with indexation.

Holding Period

Taxation on Mutual Fund

Capital gains on mutual funds are subject to taxation based on the holding period and the type of fund. Here’s the tax treatment for capital gains on mutual fund:

1. Short-Term Capital Gains (STCG):
   • If the investor sells mutual fund units within a short-term holding period (less than 36 months), the gains are classified as short-term capital gains.
   • Short-term capital gains on equity-oriented funds, including equity mutual funds and hybrid funds with more than 35% allocation to equities, are taxed at a flat rate of 15%, excluding surcharge and cess.
   • Short-term capital gains on debt-oriented funds, including debt mutual funds and hybrid funds with 35% or less allocation to equities, are taxed as per the investor’s applicable income tax slab rates.
2. Long-Term Capital Gains (LTCG):
   • If the investor sells mutual fund units after holding them for a long-term period (36 months or more), the gains are classified as long-term capital gains.
   • Long-term capital gains on equity-oriented funds, including equity mutual fund and hybrid funds with more than 35% allocation to equities, are taxed at 10% for gains exceeding ₹1 lakh in a financial year, without indexation.
   • Long-term capital gains on debt-oriented funds, including debt mutual fund and hybrid funds with 35% or less allocation to equities, are taxed at 20% with indexation benefit.

Note: For debt funds and hybrid debt-oriented funds (including floater funds) purchased on or before March 31, 2023, the holding period to qualify as a long-term capital asset is 36 months. Therefore, if the investment period exceeds 36 months, such assets will be considered long-term capital assets.

Note: For Debt Mutual Fund, Floater Funds, Conservative Hybrid Funds, and Other Funds (where Equity investment is ≤35%), purchased on or before March 31, 2023, the long-term capital gains will be taxed at 20% with Indexation.

Dividend Income from Mutual Fund

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:

1. 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.
2. 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:

1. Salary Income: INR 8,70,000
2. 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)
3. 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:

1. 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
2. Net Capital Gain:
   • LTCG (after STCL adjustment): INR 2,50,000 – INR 30,000 = INR 2,20,000
3. Tax on Capital Gains:
   • LTCG Tax Rate: 20%
   • LTCG Tax Amount: 20% of INR 2,20,000 = INR 44,000
4. 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.

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Official Income Tax Return filing website: https://incometaxindia.gov.in/