Income Tax On Investment In Mutual Funds

Information has been collected from various sources and submitted in this blog to make you aware about taxation policy related to investment in Mutual Fund
--You may as per your need verify the latest fact about the law/rule/ policy from your trusted Chartered Accountant or Income Tax specialist or from the office of Income Tax department or from other reliable sources.

While much of your other income, such as salary or interest income, is taxed at your slab rate, the gains you receive from mutual funds – called capital gains – have separate taxation provisions. They are called capital gains tax. 

Capital asset is that which you own for personal or investment purposes. It includes all kinds of property; movable or immovable, tangible or intangible, fixed or circulating.

Capital assets are further classified as Financial Assets and Non-Financial Assets. 

Financial assets are intangible and represent the monetary value of a physical item. Stocks(Shares) and mutual funds are the best examples of Financial Assets.

The profit (if any) that you make on your mutual fund investments when you redeem or sell the MF units is referred to as Capital Gains. It can be a Short Term Capital Gain (STCG) or a Long Term Capital Gain (LTCG) depending upon the ‘Period of Holding’. The tax that is applicable on these profits is known as ‘Capital Gains Tax’.

Capital gain is simply the profit on your investment when you sell your mutual fund units. It is the difference between the market value of your mutual fund units at the time of sale and the cost of such units. The gains come in from the appreciation in your fund’s NAV.

Capital gains can be short term or long term, depending on how long you hold the fund units. Holding period is the number of years between when you first bought a unit and sold it. What is considered short-term and long-term holding varies between equity and debt/gold mutual funds.

Tax on equity funds

Taxation rules on equity and equity-oriented funds are fairly simple. A holding period of more than 12 months qualifies as long-term holding; less than that is short term.

Equity-oriented funds have no tax on long-term capital gains; i.e., if you sell your fund after 12 months from the date you bought it, you don’t pay capital gains tax. 

On short-term holding, the capital gains tax is a flat 15 per cent, no matter which tax bracket you belong to. 

Securities transaction tax (at 0.001%) will apply on all redemptions of equity schemes. That is about one paisa for every Rs 1000 of redeemed money and hence ignorable.

All dividends from equity funds are exempt from tax, irrespective of when you receive it.

To qualify as an equity-oriented scheme as per tax rules, the fund should have at least 65 per cent of its portfolio in domestic equity shares on an average. 

By this definition, equity-oriented balanced funds are also tax-free after a one-year holding period, just like equity funds. They are also taxed at 15 per cent for short-term capital gains. 

Similarly, arbitrage funds and equity savings funds are also treated as equity for tax purposes.

International funds that invest in the stocks of other markets such as the US or Europe, will not be an equity fund as they do not hold domestic stocks to the extent of 65% (as required by tax laws). Equity fund-of-fund schemes do not enjoy the tax benefits of equity funds because they don’t hold stocks; they hold other funds.

Tax on debt funds

Debt funds, as a category, include liquid, ultra short-term, short-term, income accrual, dynamic bond, and gilt funds. It also includes all debt-oriented funds as MIPs and other hybrid non-equity funds. International funds and gold funds also follow the same taxation as debt funds.

For these funds, short-term is a holding period of less than 36 months. Long-term holding is a period more than 36 months. 

On short-term capital gains, you are taxed at your slab rate. That is, if you’re in the 20% tax bracket, you pay 20% of your capital gains as tax. If you’re in the 10% tax bracket, you pay 10% tax on your capital gain.

On long-term capital gains, your tax is 20% of the gain with cost indexation benefits. Indexation is the method by which your cost is adjusted for inflation. What this does is to effectively reduce your absolute gain, as your cost goes up and thus reduces your taxable profit. (We’ll do a detailed post on indexation soon!)

While equity funds do not suffer tax on dividend, debt funds do! You do not pay this tax – called dividend distribution tax (DDT). The AMC deducts it from your NAV and remits it directly. So you receive dividend net of DDT.

The DDT rate for individuals at present is 28.84% (including surcharge and cess). Do note that as dividends are paid out from your NAV, your NAV falls post such dividend payout or reinvestment. Hence, the capital gains, if any, when you sell your units under this option will seem lower. But the fact remains that you paid tax on the dividend, which is nothing but part of your profit.

Hence, it is important for you to know whether it is suitable for you to opt for dividend option in debt, depending on your tax profile. We will do a separate article on how to optimally use the dividend and growth option.

In brief following question arises:-

What are the  factors that determine the tax status of mutual funds?– 

What are the tax implications on mutual fund investments? – 

Mutual funds taxation & capital gains tax rates on mutual funds for Financial year 2016-2017 (Assessment year 2017-2018).

Factors determining the tax status of mutual funds

The capital gains tax on mutual fund withdrawals is based on the factors as below;

1. Residential Status ( Resident or Non-Resident )

   2. Fund Type  (whether the fund is an Equity-oriented fund (or) a Non-Equity Oriented Fund)

    3. Holding Period (Duration of your investment)

1. Residential Status & Mutual Funds Taxation

The capital gains tax rates are determined based on the residential status of an individual / investor. Residential status can be either ‘Resident Indian’ or ‘Non-Resident India” (NRI).

2. Type of Funds & Mutual Funds Taxation

What are Equity-oriented Mutual Funds? 

– MF schemes that invest at least 65% of its fund corpus into equity and equity related instruments are known as equity mutual funds. Examples are : Large cap, Mid-cap, Balanced funds (equity oriented), Sector funds etc.,

What are Non-Equity Mutual Funds? – 

MF schemes that hold less than 65% of their portfolio in equities and equity related instruments are known as Non-Equity Funds / Debt funds. Examples are : Liquid Mutual funds, Money Market funds, Gold funds, Infrastructure debt funds, Balanced funds (Debt oriented) etc.,

3. Period of Holding & Capital Gains on Mutual Funds

Capital gains on Mutual funds could be either long term capital gains or short term capital gains, depending on your investment horizon.

• Long Term Capital Gains
• If you make a gain / profit on your investment in a Equity Mutual Fund scheme that you have held for over 1 year, it will be classified as Long Term Capital Gain.
• If you make a gain / profit on your investment in a Non-Equity Mutual Fund scheme (or in a Debt Fund) that you have held for over 3 years, it will be classified as Long Term Capital Gain.
• Short Term Capital Gains
• If your holding in a Equity mutual fund scheme is less than 1 year i.e. if you withdraw your mutual fund units before 1 year, after making a profit, then the profit will be considered as Short Term Capital Gain.
• If you make a gain / profit on your Debt fund (or other than equity oriented schemes) that you have held for less than 36 months (3 years), it will be treated as Short Term Capital Gain.

Capital Gains Tax Rates on Mutual Funds for FY 2016-17 (AY 2017-2018)

Capital Gains Tax Rates on Mutual Fund Investments of a Resident Indian are as below;

• The STCG (Short Term Capital Gains) tax rate on equity funds is 15%.
• The STCG tax rate on Non-Equity funds (or) Debt funds is as per the investor’s income tax slab rate.
• The LTCG (Long Term Capital Gains) tax rate on equity funds is NIL.
• The LTCG tax rate on non-equity funds is 20% (with Indexation benefit)

Capital Gains Tax Rates on NRI Mutual Fund Investments for the Financial Year 2016-17 (Assessment Year 2017-18) are as below;

• The STCG tax rate on equity funds is 15%.
• The STCG tax rate on Non-Equity funds (or) Debt funds is as per the investor’s income tax slab rate. (Tax Deducted at Source – TDS @ 30% is applicable)
• The LTCG tax rate on equity funds is NIL.
• The LTCG tax rate on non-equity funds is 20% (with Indexation)on listed mutual fund units and 10% on unlisted funds.

Taxation of Mutual Fund Dividends

• Dividends on Equity Mutual Funds : The dividend received in the hands of unit holder for an equity mutual fund is completely tax free. The dividend is also tax free to the mutual fund house.
• Dividends on Debt Funds : The dividend income received by a debt fund unit holder is also tax free. But, the mutual fund company has to pay a dividend distribution tax (DDT) before distributing this dividend income to its Unit-holders. DDT on Debt Mutual Funds is 28.84%.

NRI Mutual Fund Investments & TDS Rate 

Below are the TDS rate applicable on MF redemptions by NRIs for AY 2017-18.

Who pays the tax?

If you are a resident Indian, the fund house will not deduct any tax (TDS) when you sell your units. You are required to show the income and pay taxes, if any, when you file your returns. If you are a non-resident Indian, while the tax laws remain the same for capital gains, TDS will be deducted, at the applicable rates, when you sell your units.

Remember that any transaction that involves units going out of your holding qualifies as redemption. So if you’re switching units from one scheme to another or from the dividend to growth option (or vice versa), or making a systematic transfer plan or a systematic withdrawal plan, they’re all redemptions.

Why should I invest in mutual funds?

These days between work, family, and friends, most of us do not have the time to make or monitor personal investment decisions on a regular basis. Mutual funds have qualified professionals who do all this for you. This is the reason why, the world over, they have become the most popular means of investing.

Mutual funds minimise risk by creating a diversified portfolio while providing the necessary liquidity. Additionally, you benefit from the convenience of not having to bother with too much paperwork or repeat transactions. It is our belief that investors differ in their investment needs based on their personal financial goals.

It is recommended that you should, at the very beginning, identify your own financial goals, be it planning for a comfortable retired life or children's education. After defining the financial goals, you need to plan for them in an organised manner and look at investments that help achieve these goals.

Mutual funds vary in their investment objectives, thus providing you with the flexibility to create an investment plan based on individual financial goals. Investment experts recommend growth investments such as equity funds and stocks as a good choice for funding needs that are five years or more away, income funds to meet medium-term needs and liquid funds for short-term requirements.

What are tax implications to resident unitholders?

(As per laws currently in force)

A) Tax Implications To Unitholders

The following summary outlines the key tax implications applicable to unit holders based on the relevant provisions under the Income-tax Act, 1961 ('Act'), the Wealth-tax Act, 1957 and the Finance Act, 2006 (collectively called 'the relevant provisions').

The following information is provided for general information only. However, in view of the individual nature of the implications, each investor is advised to consult with his or her own tax Advisors/Authorised dealers with respect to the specific tax and other implications arising out of his or her participation in the schemes.

Under The Income-Tax Act, 1961

The following summary outlines the key tax implications applicable to unit holders based on the relevant provisions under the Act, taking into account the amendments made by the Finance Act, 2006.

The tax implications of the following income received by the investors are discussed below:

• Income on units (other than sale/redemption);
• Income on sale/redemption of the units

Taxability of income on units (other than sale).
The income received by an investor (other than income on sale/redemption) in respect of units of a mutual fund specified under Section 10(23D) of the Act, is exempt under the Act.

As the income is exempt from tax, no tax is withheld by the Mutual Fund upon distribution of such income.

Taxability of income on sale/redemption of units. The taxability of the income on sale/redemption of units and the rates at which such income is taxed is discussed below:

If the units are held as stock-in-trade. If the units are held by an investor as stock-in-trade of a business, the said income will be taxed at the rates at which the normal income of that investor is taxed. The rates applicable to different investors are discussed at length in Note 1.

On sale of the units of an equity oriented fund (as defined below) on a recognised stock exchange or to the Mutual Fund, the investor will also be charged with securities transaction tax ('STT') as per the rates specified in para 15.5, provided the transaction is also considered as a taxable securities transaction. In other cases, STT is not levied.

Further, the investor is not allowed any deduction of STT paid for the purposes of computing his business income. However, a rebate under section 88E of the Act is available in respect of STT paid. The rebate is available in form of a deduction of the STT paid from the tax payable on the income from the taxable securities transaction. The tax payable on the income from taxable securities transaction is computed by applying the average rate of income-tax on the total income. The rebate in respect of STT paid cannot, however, exceed the tax payable. Also, this rebate can be claimed by an investor only if appropriate evidences are furnished in Form No. 10DB along with the Return of Income.

If the units are held as investments:

If the units are held as investments, the tax rates applicable will depend on whether the gain on sale of units is classified as a short term capital gain or a long term capital gain. As per section 2(42A) of the Act, units of the scheme held as a capital asset, for a period of more than 12 months immediately preceding the date of transfer, will be treated as long-term capital assets for the computation of capital gains; in all other cases, they would be treated as short-term capital assets.

The tax rates applicable on short term or long term capital gains arising on transfer of units of a scheme, being an equity oriented fund are stated in the following table:

Nature of income Tax rate $

Short-term capital gains on sale either to the Mutual Fund or on a recognised stock exchange Capital gains tax payable at 10 percent* [applicable to all investors including Foreign Institutional Investors (FII)]

Long- term capital gains on sale either to the Mutual Fund or on a recognised stock exchange No capital gains tax payable by any investor.

* plus surcharge and education cess as may be applicable (refer Note 2). In case of non-resident investors, the above rates would be subject to applicable treaty relief. $ Additionally, STT would be payable at the rates specified in para Securities Transaction Tax.

"Equity oriented fund" is defined to mean a fund -

• Where the investible funds are invested by way of equity shares in domestic companies to the extent of more than sixty five percent of the total proceeds of such fund; and
• Which has been set up under a scheme of a Mutual Fund specified in section 10 (23D) of the Act.

The tax rates applicable on short term or long term capital gain arising on transfer of units of a scheme, not being an equity oriented fund as discussed above are stated in the following table:

Nature of income Tax rate

Short-term capital gains In case of FIIs, 30 percent* For others, taxed at normal tax rates (as explained in Note 1).

Long-term capital gains In case of FII's, 10 percent* (without indexation) In case of others, 20 percent* (with indexation) or, 10 percent* (without indexation), whichever less. 

* plus surcharge and education cess as may be applicable (refer Note 2). In case of non-resident investors, the above rates would be subject to applicable treaty relief.
# no indexation benefit for non-resident investors if investment made is in foreign currency.

The withholding tax implication (i.e. TDS) in respect of the capital gains explained above is discussed below

• Resident Investors: No tax is required to be deducted at source from capital gains arising to resident investors at the time of repurchase or redemption of the units.
• Non-Resident Investors: As per the provisions of Act [Section 195], tax is required to be deducted at source from the sale proceeds or redemption proceeds paid to non-resident investors. This withholding is in addition to the STT payable, if any, by the investor. The rates are:
  
  1. Foreign Institutional Investors: No tax has to be deducted on redemption/sale proceeds [Section 196D(2)].
• 
  2. Non-Resident Indian ('NRI') / Person of Indian origin ('PIO'): Tax on short term capital gains arising out of redemption of units is deducted at the rate of 10% (plus surcharge) for an equity oriented fund and at 30% (plus surcharge) for a non equity oriented fund. Tax, on long term capital gains is deducted at the rate of 20% (plus surcharge). However, in case of long term capital gains on redemption of units of an equity oriented fund, no tax would be deducted. For administrative purpose the Fund will deduct 10% surcharge.
• 
  3. Non-Resident Corporates: Tax is deducted at the rate of 40 percent on short term capital gains and 20 percent on long-term capital gains. The said rates at which capital gains are charged to tax would be further increased by the applicable surcharge and education cess stated in Note 2 below. No tax would, however, be deducted in case of long term capital gains on redemption of units of an equity oriented fund.

All the above non-resident investors may also claim the tax treaty benefits available, if any. For details of applicability and eligibility of such benefits, the investors are requested to consult their tax advisors.

Provisions regarding Dividend income and Bonus.

According to the provisions of Section 94(7) of the Act, losses arising from the sale/redemption of units purchased within 3 months prior to the record date (for entitlement of dividends) and sold within 9 months after such date, is disallowed to the extent of income on such units (other than on sale/redemption) claimed as tax exempt.

According to the provisions of Section 94(8) of the Act, if an investor purchases units within 3 months before the record date (for entitlement of bonus) and sells/redeems the units within 9 months after that date, and by virtue of holding the original units, he becomes entitled to bonus units, then the loss arising on transfer of original units shall be ignored for the purpose of computing his income chargeable to tax. In fact, the loss so ignored will be treated as cost of acquisition of such bonus units.

Note 1. The individuals (including NRIs/PIOs) and HUFs, are proposed to be taxed in respect of their total income at the following rates:

Slab Tax rate *

Total income upto Rs.1,00,000#

Nil

More than Rs.100,000# but upto Rs.150,000

10 percent of excess over Rs.100,000 

More than Rs.150,000 but upto Rs.250,000

20 percent of excess over Rs. 150,000 + Rs.5,000$ 

Exceeding Rs.250,000 30 percent of excess over Rs 250,000 + Rs.25,000$.

* plus surcharge and education cess as may be applicable (refer Note 2). # for females below sixty-five years of age, Rs. 100,000 has to be read as Rs. 135,000 and for senior citizens above sixty-five years of age, Rs. 100,000 has to be read as Rs. 185,000.
$for females below sixty-five years of age, Rs. 5,000 has to be read as Rs. 1,500 and Rs 25,000 has to be read as Rs 21,500. Similarly for senior citizens above sixty-five years of age, Rs. 5,000 has to be read as nil and Rs 25,000 has to be read as Rs. 13,000.

The corporate tax rate for domestic companies is 30 per cent [plus applicable surcharge (as per note 2) and education cess]. However, the tax rate applicable to foreign companies is 40 per cent [plus applicable surcharge and education cess (as per note 2)].

Note 2

Assessee Rate of Surcharge Applicable

Individuals (including NRIS/ PIOs), HUFs, Non-Corporate FIIs where the taxable income is up to Rs. 1,000,000 per annum A surcharge by way of education cess of 2 percent is payable on the total amount of tax

Individuals (including NRIs/ PIOs), HUFs and Non-corporate FIIs where the taxable income is in excess of Rs. 1,000,000 per annum 10 percent basic surcharge. An additional surcharge by way of education cess of 2 percent is payable on the total amount of tax plus surcharge.

Domestic Companies 10 percent basic surcharge. An additional surcharge by way of education cess of 2 percent is payable on the total amount of tax plus surcharge.

Foreign Companies (including corporate FII) 2.5 percent basic surcharge. An additional surcharge by way of education cess of 2 percent is payable on the total amount of tax plus surcharge.

Under The Wealth-Tax Act, 1957

Units are not to be treated as assets as defined under Section 2(ea) of the Wealth-Tax Act, 1957 and hence will not be liable to wealth-tax.

B) Tax Implications On Mutual Fund

Income Earned Or Received By The Mutual Fund. Franklin Templeton Mutual Fund is registered with SEBI and as such, the entire income of the Fund is exempt from income tax under Section 10(23D) of the Act. In view of the provisions of Section 196(iv) of the Act, no income tax is deductible at source on the income earned by the mutual fund.

Income Distributed By The Mutual Fund. As per provisions of the Act (Section 115R), Franklin Templeton Mutual Fund will be required to pay dividend distribution tax ('DDT') as follows:

• No DDT to be paid on equity oriented funds
• DDT to be paid on other funds at the following rates:
  
  1. at 14.025 percent (including a surcharge of 10 percent and an additional surcharge by way of education cess of 2 percent on the amount of tax plus surcharge) on dividend distributed to individuals and HUFs; and
  2. at 22.44 percent (including a surcharge of 10 percent and an additional surcharge by way of education cess of 2 percent on the amount of tax plus surcharge) on dividend distributed to persons other than individuals and HUFs, for instance, corporates.

Securities Transaction Tax. Franklin Templeton Mutual Fund, is liable to pay a securities transaction tax as follows:

Sr.No Taxable securities transaction Rate (per cent)

1 Purchase of an equity share in a company or a unit of an equity oriented fund, where

(a) the transaction of such purchase is entered into in a recognised stock exchange; and

(b) the contract for the purchase of such share or unit is settled by the actual delivery or transfer of such share or unit 0.125

2 Sale of an equity share in a company or a unit of an equity oriented fund, where

(a) the transaction of such sale is entered into in a recognized stock exchange; and

(b) the contract for the sale of such share or unit is settled by the actual delivery or transfer of such share or unit 0.125

3 Sale of a derivative, where the transaction of such sale is entered into in a recognized stock exchange 0.017

4 Sale of unit of an equity oriented fund to the Mutual Fund 0.25

The value of a taxable securities transaction will be as follows:

• in the case of a taxable securities transaction relating to "option in securities", the aggregate of the strike price and the option premium of such "option in securities"
• in the case of taxable securities transaction relating to "futures", the price at which such "futures" are traded; and
• in the case of any other taxable securities transaction, the price at which such securities are purchased or sold

"Taxable securities transaction" means a transaction of -

• purchase or sale of an equity share in a company or a derivative or a unit of an equity oriented fund, entered into in a recognised stock exchange; or
• sale or an equity oriented fund to the Mutual Fund

Please note that the information provided above is for general information purpose only and the prospective investors should not treat this information as advice relating to taxation or investment or any other matter. 

In view of the individual nature of the implications, each investor is advised to consult with his or her own tax advisors/authorised dealers with respect to the specific tax and other implications arising out of his or her participation in the schemes.