Mutual fund Taxation

Mutual Fund Taxation (Part 1)

Definition: Mutual fund taxation refers to the tax implications associated with investing in mutual funds.
Details: It is essential to understand the taxation associated with mutual fund investments, as it affects the investor's returns.

Applicability of Taxes: Mutual funds are pass-through vehicles, and taxes are applicable at two levels: income earned by the fund and income earned by the investor.
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. As per the Income Tax Act, mutual fund income is exempt from income tax.
Income Earned by the Investor: Investors can choose between Income Distribution cum Capital Withdrawal (IDCW) option and growth plan. The tax treatment differs for these two options.

Type of Income: Capital gains and dividend income have different tax treatments.
Holding Period: Capital gains are categorized as short-term and long-term based on the holding period.
Type of Mutual Fund Schemes: Equity-oriented and non-equity-oriented funds have different tax rates.
Type of Investor: Tax treatment varies for Resident Indian Investors, NRIs, and non-individual investors.

Definition: Capital gains arise when a unitholder sells units of a scheme at a price different from the purchase price.
Taxation: Capital gains are subject to tax, and the tax rates vary based on the holding period and type of fund.
Classification: Capital gains are classified into short-term and long-term, with holding periods of 12 months and 24 months, respectively.

Introduction: The concept of grandfathering was introduced to avoid retrospective taxation when long-term capital gains tax was introduced in 2018.
Base Point: The valuation of equity mutual funds as on January 31, 2018, becomes the base point for calculating gains.
Exemption: The first Rs. 1.25 lakhs of long-term capital gains from equity shares and equity-oriented mutual funds are tax-exempt.

Taxation: Dividend income from mutual funds is taxable in the hands of the investor, with the applicable tax rate based on the total income for the year.
Change: The dividend distribution tax has been done away with, and dividends are now added to the taxable income of the assessee.
Impact: The tax rate on dividend income varies based on the investor's tax slab, and tax-exempt investors are no longer affected by the dividend distribution tax.

Tax on Dividend: The post-tax dividend received by the investor is calculated as the dividend paid out by the scheme minus the tax payable thereon, as per the applicable tax slab.
Growth Option: This option is more tax-efficient since mutual fund schemes are tax-exempt, and capital gains are realized only when booked, allowing for deferment of taxes and the benefit of compounding before tax.

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

Capital Loss: Cannot be set off against any other head of income (e.g., salaries).
Short Term Capital Loss: Can be set off against short-term capital gain or long-term capital gain.
Long Term Capital Loss: Can only be set off against long-term capital gain.

STT Applicability: Applicable only on redemption/switch to other schemes/sale of units of equity-oriented mutual funds, whether sold on the stock exchange or otherwise.
STT Rates:
- Purchase: Nil
- Sale (delivery-based): 0.001%
- Sale (non-delivery based): 0.025%
- Sale to the mutual fund: 0.001%

ELSS: Equity Linked Savings Schemes are eligible for deduction under Section 80C, with a lock-in period of three years from the date of investment.
Tax Exemption: Available up to Rs. 1.50 lacs per year per taxpayer for individuals and HUFs.
Nuances:
- Investment through SIP: each investment is locked-in from the date of the respective investment.
- Dividend reinvestment: attracts a 3-year lock-in.
- Tax benefit available to the first holder in case of joint holding.

TDS on Repurchase: No TDS on re-purchase proceeds to resident investors.
TDS on Dividend: Applicable at 10 percent on the dividend amount if it exceeds Rs. 5,000.
DTAA: Double Taxation Avoidance Agreements specify rates for Withholding Tax.

GST on Fees: Charged to the scheme in addition to the overall limits specified under SEBI (Mutual Fund) Regulations.
GST on Exit Load: Deducted from the exit load, and the net amount is credited to the scheme.
GST on Brokerage: Paid for execution of trade, if any, shall be within the limit of TER.