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Tax on Mutual Funds-How to Calculate?

When you save for long term financial goals, taxation will make lot of difference on your accumulation. If you are getting it tax free like PPF, it is always good for you. Is there a tax on mutual funds? Answer is Yes and No.

Let us see how to calculate tax on mutual funds?

First of all let us study what are the heads under which we get income from mutual funds?

Tax on Mutual Funds

If your investment is in growth option of the mutual fund, your gain will be reflected by way of increase in Net Asset Value (NAV). This gain is called the Capital Gain. But, if you have opted for dividend option, your gain will be by way of periodic dividend also.

Let us see how to calculate tax on mutual funds under this 2 heads.

How to calculate Capital Gain tax on mutual funds?

1.   Equity Mutual Funds

For taxation purpose, funds with 65% or more allocation in equity are classified as Equity funds. So balanced funds like HDFC prudence, HDFC balanced etc. also will come under this category.

Suppose you have invested 1 lakh in Feb. 2005 in HDFC Prudence fund. The value of this investment is around 4 Lakhs today. How much is the capital gain? It is 4lakhs   – 1Lakhs = 3 Lakhs. You want to sell this fund today for buying a car. How to calculate tax payable in this?

Here is the good news. You need not pay any tax on this gain of 3 Lakhs. This is because the long term capital gain from equity mutual fund is tax free.

What is Long term Capital Gain?

It is the gain you are getting, when you are selling the mutual fund after 365 days of its purchase.

As per the current tax rules, Long term capital gains from equity mutual funds are tax free.

What is short term Capital Gain

It is the gain you are getting, when you are selling the mutual fund within 365 days of its purchase.

As per the current tax rules, you have to pay 15% tax on the short term capital gains from equity mutual funds. With 3% cess, it will be 15.45%.

2.   Debt mutual funds

In addition to normal debt funds, funds with less than 65% in equity, international funds, gold funds, fund of funds etc. are also considered as debt funds for taxation purpose.

In debt funds, the short term capital gains are fully taxable. You have to pay tax as per your tax slab. Suppose you are getting 30,000 as short term gain by selling a debt fund within 1 year and if your salary income is 4 lakhs, your taxable income will be 4, 30,000.

For long term capital gains in debt funds, you have to pay tax as follows

  1. 20% with indexation benefits or
  2. 10% without indexation benefits.

What is indexation?

Indexation helps you to offset your gain with the effect of inflation. Government will notify the Cost of inflation Index every year. Please note the cost of inflation index for the recent 3 financial years.

2010-11: 711,        2011-12: 785,        2012-13: 852

Let us see how to calculate capital gain for debt funds?

Suppose you have invested 1 Lakh in a debt fund in January. 2011 and is selling in Feb. 2013 for 1, 20,000.

Your original investment = 1, 00,000

Indexed cost:  1, 00,000 x 852/711 = 1, 19,831.

Capital Gain after indexation = 1, 20,000 – 1, 19, 831 = 169/- (sale price- indexed cost)

So, in this case, you have to pay 20% tax on the gain of 169/- only and not on the gain of 20,000!  Your tax liability is only 34/-. This is the benefit of indexation.

If you don’t want to apply indexation, you have to pay 10% tax on the gain of 20,000. Then the tax liability will be 2000/-.

How to calculate tax on mutual funds dividend income?

1.   Equity mutual funds

There is no tax on mutual funds dividend you receive from equity mutual funds. It is tax free in your hands.

2.   Debt mutual funds

You need not pay any tax on mutual funds dividend you receive from debt mutual fund. But the mutual fund company is liable to pay Dividend Distribution Tax to the government before paying the dividend to you.

Dividend Distribution tax in debt mutual funds (DDT)

For Liquid funds and money market funds, the DDT is 25%. There is another 5% surcharge on it along with 3% cess. So, the effective rate of tax will be 27.0375 %( 25% tax+ 5% surcharge+3% cess).

In other debt funds, the DDT rate is lower. It is 12.5 %. There is another 5% surcharge on it along with the 3% cess. So, the effective rate of tax will be 13.5188%.

Will they deduct tax on mutual funds income?

No, the fund house will not deduct the tax from your gain. You have to calculate and pay tax on mutual fund income. But for NRIs, tax on mutual funds will be deducted as per the applicable rates before paying.

What way mutual fund investment is attractive?

Here, you pay tax only at the time of redemption. But in bank deposits, you have to pay tax every year on accrual basis. With indexation benefits, debt funds are attractive than fixed deposits. Equity funds after 1 year is totally tax free.

Hope that this article was useful in understanding the tax on mutual funds. If you like it please share the article with your friends. If you have any doubts regarding tax on mutual funds, please feel free to comment.

12 Comments

  • CA Karan Batra – Tax Advisor Posted February 10, 2013 5:05 pm

    Equity oriented mutual funds are the most popular in India and attract a large quantum of investment as not only can the investment be claimed as deduction u/s 80C but the long term capital gain arising form the sale of Long Term Mutual Fund is also exempt.

    Therefore, they attract a large chunk of the Investment

    • Deepika Chatterjee Posted April 19, 2013 10:53 pm

      How to get tax benefits if one suffers losses on redemption of Mutual funds after 5 years of investment?

      • Melvin Joseph Posted April 29, 2013 7:22 pm

        There is no tax benefits attached to Long Term Capital Loss.

  • Lokesh .i Posted June 3, 2013 8:08 pm

    If we have opted growth plan in which investment is made periodically with low amounts and redeemed part of units. How to calculate cost of investment?

    • Melvin Joseph Posted June 25, 2013 6:06 pm

      You can create a folio in Value research online and monitor it easily.

  • Viral Posted June 19, 2013 10:13 am

    What are the tax implications on Arbitrage funds ? ( Growth & Dividend Reinvest)

    • Melvin Joseph Posted June 25, 2013 5:43 pm

      The taxation on this will be like debt funds.

  • Viral Posted June 19, 2013 10:15 am

    How to calculate capital gains tax when selling a mutual fund under dividend re-investment scheme ? With fortnightly dividend re-invest , there are hundreds of re-invest transactions over 3-4 years. Manually calculating for each one would be very difficult.

    • Melvin Joseph Posted June 25, 2013 5:43 pm

      Normally, fund house will give you a certificate to this effect annually. You can request them.

  • Chandrashekhar N Posted February 24, 2014 10:48 pm

    Very useful and very informative, for those who do not have knowledge on Mutual fund and tax benift in investing in mutual funds compared to investing in traditional Bank deposits

  • joginder Posted November 25, 2014 11:03 pm

    I had invested under dividend reinvestment option in a fund in 20 jan,12 and redeemed my investment in Oct,14.
    1. How do I include the dividend reinvested amount in my incometax return or is it not requiredto be included.
    2. I got capital gain statement from fund house but it is only for current year. So what about earlier period capital gain. Should I ask them to provide capital gain statement from investment date till redemption and then calculate tax liability.

    • Melvin Joseph Posted January 5, 2015 10:27 am

      You can get the capital gain statement from CAMS

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