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2 mins Read | 4 Months Ago
Mutual Funds in India are a favoured investment option due to their potential for delivering substantial returns. However, the gains accrued through these funds are subject to taxation. In 2018, late Finance Minister Arun Jaitley reintroduced the tax on long-term capital gains. Before 2018, if you held onto your investments for a year or more, you did not have to pay taxes.
Presently, it is impossible to avoid paying taxes on capital gains. Some strategic planning, though, can help in achieving tax efficiency. This has to start with understanding how capital gains are taxed.
Understanding Taxation on Mutual Funds
Taxation on Mutual Funds depends on several factors that directly influence the taxes levied on these investments:
Fund Types
Different types of Mutual Funds — Equity, Debt or Hybrid — have varying taxation rules. Each fund type has its tax implications, which investors need to understand before investing.
Dividends
Mutual Fund houses distribute a portion of their profits among investors as dividends. These dividends are subject to taxation and investors need to be aware of their tax implications.
Capital Gains
Capital gains occur when investors sell their assets at a higher price than their initial investment. Understanding the types — short-term and long-term — of capital gains and their respective tax rates is crucial.
Holding Period
The period between the purchase and sale of Mutual Fund units significantly impacts the tax rate. Longer holding periods generally attract lower tax rates, fostering a more tax-efficient investment strategy.
Capital Gains Tax on Mutual Funds
Capital gains arising from Mutual Fund investments are subject to taxation, determined by various factors such as fund type, holding period and the nature of gains, be it short-term or long-term.
Fund Types and Corresponding Tax Rates:
Equity Funds and Hybrid Equity-Oriented Funds: For holding periods that are shorter than 12 months, the tax rate is 15%. For more than 12 months, the tax rate is 10%, but it's exempted for gains up to Rs 1 lakh.
Debt Funds and Hybrid Debt-Oriented Funds: For holding periods that are shorter than 36 months, you are taxed as per the Tax Slab Rate. For more than 36 months, the tax rate is 20%.
Understanding these categories and their corresponding tax rates is crucial for investors, as it directly impacts the tax liabilities arising from their Mutual Fund investments. More importantly, having an idea about funds and their tax rates helps in making strategies to become tax efficient.
Strategies to Reduce Capital Gains Tax on Mutual Funds
Tax Harvesting
Utilising tax harvesting involves selling a portion of Equity Mutual Fund units annually to realise long-term gains and subsequently reinvesting the proceeds into the same fund. By following this method, investors can keep their long-term returns below the Rs 1 lakh threshold, thus avoiding long-term capital gains tax upon redemption.
For instance, if an investor invested Rs 3 lakh in an Equity Fund in January 2024, with a 20% annual return and redeemed it in February 2025 for Rs 3.60 lakh, the capital gains of Rs 60,000 remained tax-free as it stayed below the Rs 1 lakh threshold for that financial year.
Capitalise on Your Losses
This approach involves booking long-term capital losses to offset against other long-term capital gains, effectively reducing the capital gains tax burden. For instance, if an investor faced a loss of Rs 40,000 on an investment valued at Rs 1.6 lakh in January 2024, they could offset this loss against any long-term capital gains booked in the same year. By doing so, investors can reduce payable capital gains tax.
Conclusion
While it is impossible to entirely avoid paying taxes on Mutual Fund gains, understanding tax implications and using strategic planning can help minimise tax liabilities. Embracing Tax Harvesting is an effective way to reduce Capital Gains Tax on Mutual Funds.
However, investors should consult financial advisors or tax experts to tailor these strategies to their specific financial goals and investment objectives, especially if they are planning to capitalise on their losses.
