Tax Implications

Work your Way up with your Wealth building Winners! (Contd.)

Performance Evaluation of Mutual Funds (contd.)

Tax Implications

What are the tax rates applicable to income from investment in Mutual Funds? What are the tax benefits you get on investing in Mutual Funds? Answers to these questions will aid you in the task of choosing between the various options.

Tax rates on income from Mutual Fund Investment

There are essentially two kinds of incomes that you would earn from Mutual Funds - Dividends and Capital Gains. If you hold on to your mutual fund investment for more than one year, it is considered to be a long-term capital asset and vice versa. Sale of a long-term capital asset attracts long-term capital gains or losses and sale of a short-term capital asset attracts short-term capital gains or losses. Tax treatment differs according to the kind of income and the tenure of investment.

Dividends from Mutual Funds are completely tax-free in your hands. However, there is a distribution tax @28.3% (including surcharge & cess) for Liquid and Money Market Funds (14.025% for other debt-oriented funds) payable by the Mutual Fund directly to the exchequer. So, in effect, you would stand to receive that much lesser dividend. Equity-oriented schemes are exempted from this tax. For this purpose, equity-oriented schemes have been defined as those schemes that have more than 65% of their assets in the form of equity.

Long-term capital gain is completely tax-free in the case of investment in equity-oriented mutual funds. In the case of debt-oriented funds, long-term capital gain attracts tax at 20% with indexation benefit or 10% without indexation benefit, whichever is lower. Indexation is simply using the cost inflation index tables published by the government to increase your investment cost to the extent of inflation. This is good because it reduces the amount of capital gain and the amount you end up paying as tax. NRIs do not have the cost inflation indexation benefit.

In the case of equity-oriented funds, short-term capital gain is taxable at 10%. Since long-term capital gain is tax-free, long-term capital loss will not be available for set off against capital gain. Short-term capital loss will, however, be available for set-off against short-term capital gain. In the case of debt-oriented funds, short-term capital gain is taxed at the tax rate applicable to your total income. In view of the increase in education cess in the current budget, your rate of short-term capital gains tax will climb to 33.9 per cent if you are in the 30 per cent bracket and 23.6 per cent, if you are in the 20 per cent bracket. While long-term capital losses can only be set off against long-term capital gains, short-term capital losses can be set off against, both, short-term capital gains as well as long-term capital gains.

In the case of resident Indians, there will be no tax deducted at source (TDS) on capital gains. However, in the case of non-residents, tax will be deducted at source.

Securities transaction tax of 0.25% is being levied on all redemptions (including switch outs) in equity-oriented mutual funds. There is no securities transaction tax on debt-oriented funds.

Tax benefits on investment in Mutual Funds

The amount invested in Equity Linked Savings Scheme (ELSS) would be eligible for deduction upto a maximum of Rs 100,000.

To avoid capital gains tax, the capital gain, which is not exempt from tax, can be invested in the specified asset (any bond redeemable after 3 years issued by National Highways Authority of India (NHAI) and Rural Electrification Corporation Ltd.) within 6 months of the sale.

There is no wealth tax or gift tax applicable to mutual fund investment.