Investment in mutual funds generates income which is taxable under two heads:
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Mutual fund is a capital asset. So, profit or gain arising from the sale of mutual fund units is a capital gain. Capital gains on mutual funds are taxed in the year in which you sell the mutual fund units. Capital gains arising from the sale of mutual funds, can either be short-term capital gains or long-term capital gains.
The amount of tax to be paid on capital gains arising from the sale of mutual funds, depends on the time you stay invested in them. This is called the holding period of mutual funds.
Holding period of mutual funds can be of two types:
Let us now look at the tax implications of short-term gains and long-term capital gains on different types of mutual funds:
Equity-Linked Saving Scheme also known as ELSS, is the most efficient tax-saving mutual fund. ELSS is a diversified mutual fund. They are invested in equity shares of small-cap, mid-cap and large-cap companies. You can claim tax deduction towards investment in ELSS under Section 80C of the Income Tax Act, 1961, up to the ceiling limit of Rs 1,50,000 a year. ELSS can save you taxes up to Rs 45,000.
ELSS has a lock-in period of 3 years. Therefore, you can only earn long-term capital gains from ELSS. After 3 years, on redemption of the ELSS units, LTCG up to Rs 1 Lakh are tax-free. LTCG beyond Rs 1 Lakh is taxed @10% without indexation benefit.
• Long-term capital gains on all other equity mutual funds of up to Rs 1 Lakh are tax-free; any amount in excess of Rs 1 Lakh is taxed @10% without indexation benefit.
• Short-term capital gains (STCG) on the sale of other equity funds before 12 months are taxed @15%.
• A tax @20% is charged for long-term capital gains on debt funds after indexation. Indexation is a method to consider the rise in inflation between the year of purchase of debt fund units and the year when they are sold. Thus, indexation brings down the quantum of capital gains.
• Short-term capital gains from debt funds are added to income and taxed as per income tax slab that is applicable to you.
Balanced funds are also known as hybrid funds.
SIP stands for systematic investment plans. It is a method of investing in mutual funds. Taxation rules for gains from SIPs changes according to the type of mutual fund and the holding period.
For taxation purposes, each individual SIP is treated as a fresh investment taxed separately.
Say you begin a SIP of Rs 10,000 a month in an equity fund for a year. Every SIP, i.e. investment of each month is considered to be a separate investment. If you decide to sell the entire corpus, i.e. investments plus gains, all your gains will not be tax-free. The gains on the first SIP, i.e. first-month investment will be tax-free. This is because only that particular month’s investment will have completed a year. The rest will be subject to short-term capital gains.
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