How to calculate Tax on Mutual Funds in India? A Mutual Fund is more tax-friendly compared to other investments in India. This is because of the way Tax on Mutual Funds in India is calculated. If you invest Rs. 1 Lakh in bank deposit for a period of 3 years, you are liable to pay Tax on the Interest Income every year on accrual basis. Even before the interest income is reaching your hands, you are liable to pay tax on it, that too, at your marginal rate of tax. But Tax on Mutual Funds in India is calculated not on the accrual basis. Here, you are liable to pay tax only at the time of selling the mutual funds and that too at reduced rates.
Let us discuss how Tax on Mutual Funds in India is calculated. There are 2 types of Income from Mutual Funds. They are:
- Dividend Income
- Capital Gain
Tax on Mutual Funds in India – On Dividend Income
The Dividend Income you are receiving is totally tax free. You need not pay any tax on it. But in the case of Debt Mutual Funds, the AMC will pay you the dividend only after paying Dividend Distribution Tax (DDT). The current rate of DDT is 25%. There is a surcharge of 10% and 3% education cess on it. With these, the actual rate of DDT is 28.325%.
By opting for growth option in Debt Funds, you can avoid the effect of DDT. But there is no DDT for Equity Mutual Funds.
Tax on Mutual Funds in India – On Capital Gain
Instead of Dividend Option, if you have opted for the Growth Option in Mutual Funds, you will not get dividend. But your gain will be reflected by the increase in NAV of the Fund. This gain is called the Capital Gain. If the NAV of the unit was 15 while purchasing it 2 years back and if it is 20 now, the Capital Gain is 5 per unit.
If you are selling the Mutual Fund units within 365 days from the date of purchase, such gains are called Short Term Capital Gains. But if you are selling the units after 365 days, such gains are called Long Term Capital Gains. The method of calculation of tax on Capital Gain is different for equity and non equity funds. Let us see this in details.
A. Equity Funds
Funds which allocate 65% or more of its corpus in Equity are classified as Equity Funds for the purpose of taxation.
The Short Term Capital Gains from Equity Funds will be taxed at the concessional rate of 15%, irrespective of your tax slab. With the addition of 3% education cess, the effective rate of tax here will be 15.45%.
The Long Term Capital Gains are tax free in the case of Equity Funds.
B. Debt Funds / Non Equity Funds
Funds like Gold Funds, International Funds, Fund of Funds and Hybrid Funds, where the allocation to Equity is less than 65% of the corpus, are also treated similar to Debt Funds for taxation.
In these funds, the Short Term Capital Gains will be taxable as per your marginal tax rate. If you are in 30% tax slab, you have to pay 30% tax on any Short Term Capital Gains like this.
You have to pay the lower of the following two as Long Term Capital Gains tax in Debt Funds/Non Equity Funds:
- 20% with indexation benefits or
- 10% without indexation benefits
What is Indexation in Mutual Fund taxation?
Indexation is a facility for investors to escape from the adverse effect of inflation. Tax department will notify the Cost of Inflation Index on an annual basis, depending on the prevailing inflation rate in the country.
The index values for the last 2 years are given below:
- 2011-12: 785
- 2012-13: 852
You can see from the above values, that there is an increase of around 8.5% in the value for 2012-13 from the value for 2011-12. Let us see how Indexation will help you in reducing tax on Long Term Capital Gains.
Suppose, you had invested Rs. 2 Lakhs in a Debt Fund in 2011-12 and sold it in 2012-13, after 365 days of holding for Rs. 2,18,000. The indexed cost of investment will be calculated as follows:
Indexed Cost of Investment: Rs. 2,00,000 x 852/785 = Rs. 2,17,070.
Capital Gains after Indexation = Rs. 2,18,000 – Rs. 2,17,070 = Rs. 930. (Sale Price – Indexed Cost)
Your Tax liability in this case will be 20% on the gain of Rs. 930. This works out to Rs. 186.
Without Indexation, your Tax liability will be 10% of the gain of Rs. 18,000. This works out to Rs. 1,800.
You have to pay the least of the above two. Your Tax liability on this gain of Rs. 18,000 will be Rs. 186 only.
Tax on Mutual Funds in India – boon for your investments
In the above example, you got Rs. 18,000 as gain. But your Tax liability is only Rs. 186. If you had got similar gain from a bank deposit, you had to pay tax as per your slab rate for the entire Rs. 18,000. If you are in the 30% tax slab, your tax liability will be Rs. 5,400.
Mutual Funds offer better tax treatment on your investments. Equity Funds after 1 year is totally tax free. Debt Funds with Indexation benefits attract very low tax.
Now you know, how to calculate “Tax on Mutual Funds in India”.