Mutual funds – Tax efficient investments
Bank deposits are attractive investments now with returns in the range of 8-9%. But are you aware of the effect of tax on the interest received? You have to pay tax on the interest earned as per your tax slab. Now, even deposits in cooperative banks attract TDS. But you can save on tax, if you adopt the mutual fund route.
Let us discuss the way mutual fund gains are taxed.
Equity Mutual Funds
Equity mutual funds, where equity holding is more than 65% of the total portfolio enjoy preferred status as far as taxation is concerned. Most of the balanced funds also fall under Equity Funds, because they maintain more than 65% in equity.
Income from a mutual fund can be divided into 2 parts
1. Increase in the value of investment (capital Gain)
2. Dividends
Let us see how tax is calculated on the above 2 income from Equity Mutual funds.
Capital Gain is the increase in the value of your investment. For taxation, it is divided into short term and long term.
Short term capital Gain arises if investment is held for less than 1 year. Short Term Capital gains on Equity Mutual Funds are taxed at 15%. (15.45% with 3% cess)
Long Term Capital Gain arises if investment is sold after 1 year. Long term capital gain on equity mutual funds are tax free. This makes equity mutual funds attractive for long term investing.
The dividend income from Equity mutual funds are also tax free. There is no dividend distribution tax also in case of equity mutual funds.
Debt Mutual Funds
All other funds which will not qualify as equity fund, including Fund of Fund and international Fund will be treated as debt funds for taxation. Definition of Short Term and Long Term is different for debt funds.
Short Term Capital gain arises due to selling of debt fund before 3 years will be added to investor’s income and taxed according to his tax slab.
For Long Term Capital gain, the tax will be 20% on the capital gains after indexation.
What is Indexation?
Indexation will offset the effect of inflation to some extent. In order to determine the capital gains after accounting for inflation, the indexed cost of acquisition is subtracted from the sale value. You need to pay tax of 20% only on this difference. In periods of high inflation like this, the tax liability will be almost zero after indexation.
Dividend income from Debt Mutual Funds is tax free in your hand. But there is dividend distribution tax (DDT) paid by mutual funds to income tax department. Dividend Distribution Tax (DDT) on debt funds is 28.325% (25% Tax + 10% Surcharge + 3% Cess) and will be deducted from the dividends.
It makes sense to plan your investments through mutual funds to reduce the tax burden on your gains. You can decide a mix of equity and debt funds, as per your risk profile and investment term. This can reduce your tax liability, compared to other investments.
Melvin Joseph
SEBI registered Investment Adviser
SEBI registration number -INA 000000342
Finvin Financial Planners
10. Ground Floor, Olive Excel CHS Ltd
Plot No- 16, Sector 42, Nerul, Navi Mumbai – 400 706
Mobile: 91 9820843739
Website: http://www.finvin.in
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