Different Tax Benefits of Mutual Funds in India

A mutual fund is an investment vehicle that pools financial resources from investors sharing a common investment objective and invests the sum accumulated across various asset classes and money market instruments to generate capital appreciation. Investors need not directly invest in any asset class or fixed income security as the mutual fund does this job for them. Also, the mutual fund manager carefully analyses and builds a portfolio of securities to offer investors active risk management. There is no concentration risk like in stocks, as mutual funds invest in a basket of securities.

Mutual funds can be broadly categorized as – equity funds and debt funds.

  • Equity mutual funds are those open ended schemes that aim at generating capital appreciation over the long term by predominantly investing in equity and equity related instruments of publicly listed companies
  • Debt mutual funds on the other hand invest in fixed income securities and money market instruments to offer high liquidity and stable returns while safeguarding the investment capital

For those who haven’t explored the mutual fund spectrum, they can now consider market linked schemes like equity funds because they offer tax benefit. By investing in a tax saving scheme like Equity Linked Savings Scheme, investors can bring down their tax liability and at the same time create long term wealth.

What is Equity Linked Savings Scheme?

By now you know the Equity Linked Savings Scheme or ELSS as it is commonly referred to as is an open ended tax saving scheme that comes with a tax benefit. This tax saver fund has a statutory lock-in period of three years. If you compare other tax saving instruments that come under Section 80C of the Indian Income Tax Act, 1961, ELSS has the shortest lock-in period. This can be a good tax saving option for investors who do not wish to keep their money locked in for a longer duration. As per Section 80C, a tax paying citizen can invest up to Rs. 1,50,000 per fiscal year and reduce their tax liability. However, one can invest more than the said amount in ELSS as per their investment objective but cannot claim tax benefits for an amount exceeding Rs. 1.5 lakhs.

Are mutual fund dividends taxed?

Mutual fund investors who choose for dividend option over the growth option can expect regular dividends from mutual fund investments. These investors do not have to pay any tax as dividends derived from mutual funds are treated as tax free. No tax is applicable for any type of dividend received by a mutual fund investor in India. Also, there is no upper limit on the exemption on dividends distributed by the mutual fund house to the investor.

How are capital gains from mutual funds taxed?

There are two types of capital gains tax – Short Term Capital Gains Tax (STCG) and Long Term Capital Gains Tax (LTCG)

Tax on LTCG and STCG derived equity mutual funds are different than that levied on debt mutual funds.

Tax on gains derived from equity funds

 Investors who held on to their equity mutual fund investments for more than one year, their returns are applicable for long term capital gains tax. However, only if the gains are above Rs. 1 lakh, only then a 10 percent tax is levied. Otherwise, the gains are tax free. For investors who sell their equity mutual funds within 12 months, they will have to pay a short term capital gains tax of 15 percent. Investors will have to pay this tax irrespective of the amount of the gains they earn.

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