Investors who invest in mutual funds can earn profits on their mutual fund investments either via capital appreciation or dividend recipients. Investors are often confused about the tax aspect on their mutual fund investments. This article acts as a tax guide on capital gains earned on debt funds and equity funds. Read on to know more.

Types of holding period

Different types of mutual funds have varying measures for what institutes a long-term period and what constitutes a short-term period.

  1. Long-term holding period – Equity investments that are held for more than a year are termed as long-term investments. On the other hand, debt funds are considered long term investments if they are held for more than or equal to 36 months.
  2. Short-term holding period – Equity funds are considered to be short-term investments if they are held for less than a period of 12 months. Contrary to that, debt funds with a holding period of less than 36 months are considered to be short-term investments.

Taxation on mutual funds

When the sale price of the mutual fund investments is more than the buying price, then the profits earned are termed as capital gains. Capital gains are further divided into short-term capital gains (STCG) and long-term capital gains (LTCG) depending on the holding period of the investments. Let’s understand how these capital gains play a role in determining the tax outgo on your mutual fund investments.

  1. Equity mutual funds – Under equity funds, STCG are taxed at 15% per annum irrespective of the income tax slab of the investor. LTCG on equity funds are taxed at the rate of 10% per annum without the benefit of indexation. Note that capital gains on equity funds up to Rs 1 lac on LTCG are exempt from any tax.
  2. Debt mutual funds – Under debt funds, STCG are taxed at as per the income tax slab of the investor. LTCG on debt funds are taxed at 20% with the benefit of indexation*.
  3. Hybrid mutual funds – Hybrid funds with more than 65% of their portfolio allotted to debt funds are taxed like debt mutual funds. Contrary to that, hybrid funds with more than 65% of their assets dedicated to equities are taxed like equity mutual funds.

Mode of investment

As an investor, you can invest in mutual funds via two ways – SIP (systematic investment plans) and lumpsum mode of investment. While lumpsum investment is taxed according to the start date and the end date, SIP investments do not follow the same approach. Let’s understand how SIP investments are taxed

Taxation on SIP – Unlike lumpsum investment, SIP investments are not taxed according to start date and end date of the investment tenure. Under SIP investment, for the purpose of tax, each SIP installment acts as new investment. So, for instance, if you start a monthly SIP of Rs 500 in equity funds on 1st March 2017, then on 1st March 2018, only 1/12th of the investment would have completed 1 year. Another 1/12th of the investment would have completed 11 months, and another 1/12th would have completed 10 months and so on. So, only 1/12th of the investment would be considered as long-term investment, and the rest as short-term investment.

Carry forward of losses

Investors must note that just like profits, their investments are also prone to losses. Profits on These losses (if any) can be written off against the profits. In essence, an investor can set off their short-term losses against both short-term and long-term gains. However, long-term losses can be set off only against long-term gains.

Indexation helps in adjusting the purchasing price of the mutual fund investments. It helps to reduce taxable income of the investor.

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