Know About Tax on Mutual Funds in India Here

The fiscal year 2023-24 (FY24) turned out to be the best for the domestic mutual funds industry as Assets Under management (AUM) spurted by nearly Rs 14 lakh crore to a record Rs 53.40 lakh crore as of March 2024 as against Rs 39.42 lakh crore as of March 2023, according to AMFI. That's an increase of over 35%, the second highest since the fiscal year 2020-21, when the industry had reported a 41% increase amidst the COVID-19 pandemic.

Speaking of the Indian equity markets, in FY24 the bellwether, S&P BSE Sensex -Total Return Index (TRI) clocked an absolute return of 26.2%, while the S&P BSE Mid Cap Index -TRI and S&P BSE Small Cap -TRI clocked absolute returns of 64.6% and 59.6% respectively (as of March 29, 2024).

So, if you have made capital gains or profits, plus earned dividends (if any) from your mutual fund investments or shares, or say, for some reason you booked a loss, in this article I elucidate the tax implications.

First, let's talk about Capital Gains on Equity-oriented Funds...

The capital gains are accounted for when you book a profit. In other words, when the realised sale value is greater than the cost of acquiring units of a mutual fund scheme.

In the case of equity-oriented funds and/or listed equity shares, if the holding period of the units sold is less than 12 months, it will be considered as Short Term Capital Gain (STCG).

However, when the units of equity-oriented mutual funds and/or listed equity shares are held for 12 months or more from the date of purchase/acquisition, the realised capital gains are treated as Long Term Capital Gains. Watch this video to know how investments in mutual funds are taxed:

How Are Short Term and Long Term Capital Gain Taxed in Case of Equity-Oriented Funds?

Short Term Capital Gains - These in the case of equity investments, for both equity-oriented mutual funds and listed equity shares, are taxed at a flat rate of 15% in the financial year, irrespective of the income-tax slab rate applicable to you.

Long Term Capital Gains - These in the case of equity investments are taxed at the rate of 10% on the LTCG made over Rs 1 lakh in the financial year. In other words, only LTCG more than Rs 1 lakh is taxable. If the LTCG is below Rs 1 lakh, it will be tax-exempt.

LTCG is taxed without indexation benefit in the case of equity-oriented mutual funds and listed equity shares.

To protect the interest of long-term investors, there is also a grandfathering clause (under Section 112A) introduced on February 1, 2018. This makes LTCG tax prospective, and the tax is levied only on gains from February 1, 2018.

For this purpose, to compute the cost of acquisition, the Fair Market Value (FMV) or Actual Selling Price (ASP), whichever is lower is considered. Call this as Value 1.

Further, either the aforesaid computed value (i.e. Value 1) or the Actual Purchase Price (APP), whichever is higher, is considered.

Thus, the LTCG where the grandfathering clause applies is computed after deducting the cost of acquisition as above from the sale value.

In case you are a Non-Resident Indian (NRI), tax on capital gains made will be deducted at source (STCG @15% and LTCG @ 10% without indexation benefit).

What If There Is a Capital Loss?

This occurs when you have booked a loss on the investment made, i.e. when the cost of acquisition of units of mutual funds or shares is greater than the sale value obtained.

The holding period rule also applies to capital loss. If you, the investor, have booked a capital loss in less than 12 months, it will be considered as Short Term Capital Loss (STCL).

Conversely, when a capital loss is incurred after having held units of mutual funds or shares for more than 12 months, it will be treated as Long Term Capital Loss (LTCL).

When you booked a capital loss -- whether short-term or long-term -- there is no question of tax on it.

Can Capital Gains Be Set Off Against Capital Losses?

Yes, the 'set-off and carry forward' provisions under the Income Tax Act of 1961 permit the setting of capital gains against capital losses. This allows you to save on the capital gains made on units of mutual funds and shares.

That said, there are certain rules for set off and carry forward of losses. First, it should be noted that the set-off cannot be against any other head of income when computing the total taxable income. In other words, the capital loss can be set off only against the 'Capital Gains' head.

Further, as per the rules, if there is a LTCL, it can be set off only against LTCG. Hence, only net LTCG over Rs 1 lakh will be taxable.

On the other hand, STCL (Short Term Capital Loss) is allowed to be set off against both LTCG and STCG.

As far as the carry forward of capital losses is concerned, in case you are not able to set off the capital losses in the same Assessment Year (AY), it can be carried forward up to 8 years for both Short Term Capital Loss as well as Long Term Capital Loss.

'Tax loss Harvesting' is also permitted. What it means is that the notional losses on your mutual fund and listed equity stocks portfolio can be converted to realised or actual losses. This strategy makes sense at a market high, where despite the run-up, certain mutual fund schemes or shares in your investment portfolio haven't fared well and thus may not be worth keeping. By booking a capital loss, you happen to reduce your tax outgo. You would be required to pay tax only on net capital gains.

Say you have an LTCG of 2 lakh and STCG of 60,000 but also are witnessing a notional LTCL of Rs 50,000 and STCL of Rs 40,000; by booking these losses before the end of the financial year, your net capital gain reduces to Rs 1.70 lakh (instead of Rs 2.60 lakh).

In case there is still a capital loss, as mentioned previously, that can be set off against the capital gains, it can be carried forward to the next financial year (for up to a maximum of 8 assessment years).

Therefore, Tax Loss Harvesting can be consciously used as a strategy by taking a closer look at your investment portfolio and capital gain account statement (sourced from RTAs, your distributor, or broker). Most of this data is available to you in this digital age; make sure you make the best use of it. But when you do so, carefully evaluate the holding period so as to determine short-term or long-term, as the case may be, whether for capital gains or losses. Keep in mind that tax harvesting when done sensibly may help you optimally reset your portfolio, plus consolidate and declutter it.

Capital Gains on Debt-oriented Funds

In the case of mutual fund schemes other than equity-oriented funds, i.e. debt-oriented funds and gold mutual funds, with effect from April 1, 2023, the realised capital gains made, whether short-term (holding period here is less than 36 months) or long-term (holding period of 36 months or more), are now taxed as per the tax slab applicable to you, the assessee.

In other words, debt mutual funds (including gold mutual funds) are now at par with bank fixed deposits. The indexation benefit that earlier helped to make the most of the inflation impact on the purchase value of the investment and effectively reduced the LTCG tax liability is now no longer available for Debt Mutual Funds. Watch the video below to learn about this in detail.

For NRIs, the capital gains on non-equity schemes are subject to tax deduction at source. The TDS for STCG is 30%, while for LTCG, it is 20% in the case of listed units and 10% in the case of unlisted units.

If there is a capital loss on debt mutual funds, there will be no tax liability and as mentioned before you could avail of the 'set off and carry forward' provisions under the Income Tax Act, 1961.

How Are Dividend Earned Taxed?

The dividend earned from mutual fund units (now known as Income Distribution cum Capital Withdrawal or IDCW) and shares are taxed as per your, the assessee's tax slab - in other words, at the marginal rate of taxation.

If the dividend or IDCW received is greater than Rs 5,000 in a financial year, tax is deducted at the source. The TDS rate in such a case is 10% as per Section 194 of the Income Tax Act. In case you are NRI, the TDS on the distributed income or dividend is at the rate of 20% (plus the applicable surcharge and health and education cess).

To conclude...

While you may be earning a decent sum as your annual gross total income (which includes income from your salary or business and profession, house property, and your other investments), it is important to keep a tab on the tax aspect in the interest of your financial well-being. Hard-earned money legitimately saved from tax is ultimately earned. Hence, make conscious and best efforts to save tax wisely by investing in suitable tax-saving avenues and utilising certain provisions of the Income Tax Act wisely to save tax.

"In this world nothing is certain but death and taxes" - Benjamin Franklin

Be thoughtful in your approach.

Happy Tax Planning and Investing!

Note: This write-up is for information purposes and does not constitute any kind of investment advice or a recommendation to Buy / Hold / Sell a fund. Returns mentioned herein are in no way a guarantee or promise of future returns. Mutual Fund Investments are subject to market risks, read all scheme-related documents carefully before investing.

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Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing. Registration granted by SEBI, Membership of BASL and certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors.

Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.

This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes. Use of this information is at the user's own risk. The user must make his own investment decisions based on his specific investment objective and financial position and use such independent advisors as he believes necessary.