Taxation

Taxation (Part 1)

Definition: Taxation refers to the process of levying taxes on investments, including mutual funds.
Details: Understanding taxation is crucial for investors as it affects their returns on investment.

Applicability of Taxes: Taxes are applicable on income from mutual fund investments, including capital gains and dividend income.
Income Earned by Mutual Fund Schemes: Mutual fund schemes invest in marketable securities, generating income in the form of dividend or interest, and capital gains or losses.
Tax Exemption: Mutual funds are exempt from income tax under Section 10(23)(D) of the Income Tax Act.

Income Distribution cum Capital Withdrawal (IDCW) Option: Investors may receive income in the form of dividends, which are taxable.
Growth Option: Investors may earn capital gains (or losses) when selling units, which are subject to tax.
Tax Rates: Tax rates vary based on:
- Type of Income: Capital gains are taxed differently than dividend income.
- Holding Period: Short-term capital gains are taxed differently than long-term capital gains.
- Type of Mutual Fund Schemes: Equity-oriented funds are taxed differently than non-equity-oriented funds.
- Type of Investor: Tax treatment differs for Resident Indian Investors, NRIs, and non-individual investors.

Definition: Capital gains arise from the sale of mutual fund units at a price different from the purchase price.
Taxation: Capital gains are subject to tax, with rates varying based on the holding period and type of fund.
Holding Period: Assets are classified as long-term or short-term based on a 12-month or 24-month holding period.
Grandfathering of Capital Gains: Capital gains earned till January 31, 2018, are exempt from tax.
Exemption up to Rs. 1.25 Lakhs: Long-term capital gains up to Rs. 1.25 lakhs are exempt from tax.

Taxation: Dividend income is taxable in the hands of the investor, with tax rates based on the applicable tax rate.
Change in Taxation: The dividend distribution tax has been done away with, and dividends are now added to the taxable income of the assessee.

Dividend Distribution Tax: In the earlier regime, dividend distribution tax was levied on the mutual fund, and the dividend received by the investor was net of this tax. However, in the new regime, tax on dividends is levied in the hands of the investor, and it can be reduced through various exemptions and adjustments.
Tax on Dividends: The tax on dividends in the hands of the investor can be reduced through various exemptions and adjustments, such as tax-exempt categories for charitable trusts, mutual fund schemes, and individuals in the tax-exempt slab.
NAV Reduction: Both the dividend distribution tax (old regime) and the tax on dividend income in the hands of the investor (new regime) result in a reduction in the Net Asset Value (NAV) of the scheme, which is more than the net-of-tax amount received by the investor.

Growth Option: The growth option is more tax-efficient, as mutual fund schemes are tax-exempt, and capital gains are realized only when booked, allowing for the benefit of compounding before tax.
Deferred Taxes: The growth option allows for the deferral of taxes, enabling investors to benefit from compounding before tax.

Stamp Duty: With effect from July 1, 2020, mutual fund units issued against purchase transactions are subject to a stamp duty of 0.005% of the investment amount.
Transfer of Units: The transfer of mutual fund units is subject to a stamp duty of 0.015%.

Capital Loss: A capital loss, whether short-term or long-term, cannot be set off against any other head of income, such as salaries.
Short-term Capital Loss: A short-term capital loss can only be set off against short-term or long-term capital gains.
Long-term Capital Loss: A long-term capital loss can only be set off against long-term capital gains.

Bonus Issue: If an investor buys units of a scheme and the scheme declares a bonus issue, the investor will receive additional units, but the NAV of the scheme will halve.
Capital Loss: If the investor sells the original units at a lower price, the capital loss incurred will not be available for set-off against capital gains if the original units were bought within 3 months prior to the record date and sold within 9 months after the record date.

STT Applicability: STT is applicable only on redemption, switch to other schemes, or sale of units of equity-oriented mutual funds, whether sold on the stock exchange or otherwise.
STT Rates: The STT rates vary from 0.001% to 0.025% depending on the type of transaction.

Equity Linked Savings Schemes (ELSS): Certain mutual fund schemes, known as ELSS, are eligible for deduction under Section 80C of the Income Tax Act, with a lock-in period of three years from the date of investment.
Tax Exemption: The tax exemption is available up to Rs. 1.50 lacs per year per taxpayer in case of individuals and HUFs.

TDS Applicability: There is no TDS on re-purchase proceeds to resident investors, but TDS is applicable on dividend income from mutual fund schemes, even for resident Indians, at a rate of 10% if the dividend amount exceeds Rs. 5,000.
TDS Rates: The TDS rates vary depending on the nature of the investor, investment, and income.

GST on Fees: GST is chargeable on fees paid on investment management and advisory fees, as well as on other fees, within the limits prescribed under SEBI (Mutual Fund) Regulations.
GST on Exit Load: GST on exit load, if any, shall be deducted from the exit load, and the net amount shall be credited to the scheme.

GST on Brokerage and Transaction Costs: GST on brokerage and transaction costs paid for the execution of trade, if any, shall be within the limit of Total Expense Ratio (TER).
Commission Payable to Distributors: The commission payable to the distributors of mutual funds may be subject to GST, as applicable in case of the ARN (Amateur Radio Network) holder. Such tax cannot be charged to the scheme.
Tax Applicable on Mutual Fund Income: The tax applicable on the income earned by mutual fund schemes is a function of the type of income, since:
- Dividends, Short-term Capital Gains, and Long-term Capital Gains attract different tax rates.
Securities Transaction Tax (STT): Redemption from certain mutual fund schemes would attract STT for an investor, specifically:
- Equity-oriented schemes, such as Multi-cap mutual funds.
- Schemes that are not exempt from STT, such as those investing in government securities or money market instruments, like Liquid Funds or Overnight Funds, are generally not subject to STT on redemption.
- Government Securities Funds and Liquid Funds are typically exempt from STT.
- Overnight Funds are also exempt from STT.