Taxation in Respect of Mutual Funds:
- Applicability of taxes in respect of mutual funds:
- When investing, consider taxes on investment returns.
- Mutual funds are pass-through vehicles, with income at two levels: fund income and investor income.
- Income earned by mutual fund schemes:
- Mutual fund schemes invest in marketable securities like shares and debentures.
- Securities generate income in the form of dividend, interest, capital gains, or losses.
- Mutual fund income is exempt from income tax under Section 10(23)(D) of the Income Tax Act.
- Income earned by the investor from investment in mutual fund units:
- Two options within a scheme: Income Distribution cum capital withdrawal (dividend) and growth.
- Growth option: No dividends, only capital gains (or losses) when selling units.
- Income Distribution cum capital withdrawal option: Dividends and capital gains (or losses) when selling units.
- Different tax treatments:
- Tax structure varies for different types of investors and fund categories.
- Capital gains and dividends have different tax rates.
- Short-term and long-term capital gains have different tax rates.
- Equity-oriented mutual funds have different tax rates compared to non-equity-oriented funds.
- Types of investors:
- Tax treatment varies for Resident Indian Investors, NRIs, and non-individual investors.
- Joint holdings consider income earned by the first holder.
Table: Tax Rates for Mutual Fund Income
|Type of Income||Tax Rates|
|Dividend Income||Varies based on investor's category|
|Short-term Capital Gains||Varies based on investor's category|
|Long-term Capital Gains||Varies based on investor's category|
|Equity-oriented Schemes||Varies based on holding period|
|Non-equity-oriented Schemes||Varies based on holding period|
- Capital gains arise when selling units of a mutual fund:
- Selling price can be different from the purchase price.
- Capital gain if selling price is higher, capital loss if lower.
- Classification of capital gains:
- Short-term capital gains: Holding period of less than 1 year for equity-oriented funds or 3 years for non-equity-oriented funds.
- Long-term capital gains: Holding period of 1 year or more for equity-oriented funds, or 3 years or more for non-equity-oriented funds.
- Tax rates for capital gains:
- Equity-oriented funds:
- Short-term capital gains: 15% tax rate.
- Long-term capital gains: 10% tax rate.
- Non-equity-oriented funds:
- Short-term capital gains: Marginal tax rate applicable for the investor.
- Long-term capital gains: 20% tax rate with indexation benefits.
- Income tax of 10% (without indexation benefit) on long-term capital gains exceeding Rs.1 lakh, subject to STT.
- Equity-oriented funds:
- Changes in taxation of equity-oriented funds:
- Prior to April 2018, long-term capital gains from equity funds were tax-exempt.
- Starting April 2018, long-term capital gains from equity funds are taxable at 10%.
- Grandfathering of capital gains: Gains till January 31, 2018, are not taxable to avoid retrospective taxation.
- Exemption up to Rs. 1 lakh: Only capital gains above Rs. 1 lakh are taxable for long-term gains from equity shares and equity-oriented funds.
- Benefit of indexation:
- Indexation adjusts the purchase price for inflation.
- Cost Inflation Index (CII) is used to calculate indexed cost of acquisition.
- Indexed capital gains are taxed at a lower rate.
- Indexed cost of acquisition = Actual cost of acquisition x [CII in the year of sale / CII in the year of purchase].
Note: Tax rates, rules, and CII values are subject to change as per prevailing tax laws and government notifications.
Table: Capital Gains Tax Rates
|Type of Fund||Holding Period||Short-term Capital Gains||Long-term Capital Gains|
|Equity-oriented Funds||< 1 year||15%||10%|
|Non-equity-oriented Funds||< 3 years||Marginal tax rate||20% with indexation|
|≥ 3 years||Marginal tax rate||20% with indexation|
|+ 10% tax (above Rs.1 lakh)|
Note: Surcharge and cess are applicable in addition to the base tax.
Understanding the taxation of capital gains is important for investors to assess their investment returns accurately and plan their tax liabilities effectively.
- Previous tax treatment of dividend income:
- Dividend income from mutual funds used to be tax-free in the hands of the investor.
- Dividend distribution tax was deducted from the scheme before paying dividends to investors.
- Changes in tax treatment:
- In the Union Budget of February 2020, dividend distribution tax was abolished.
- Dividends are now added to the taxable income of the recipient and taxed at the applicable tax rate.
- The tax on dividends depends on the total income and tax rate of the recipient.
- Impact of the new regime:
- Higher-income individuals may have a higher tax liability on dividend income compared to the previous regime.
- Previously tax-exempt investors, such as charitable trusts and certain individuals, remain exempt from tax on dividends.
- Difference between dividend distribution tax and tax on dividends in the new regime:
- Dividend distribution tax was not considered a setoff against other tax liabilities for investors.
- Tax on dividends in the new regime can be reduced through exemptions and adjustments applicable to the recipient.
- Impact on NAV:
- Both dividend distribution tax and tax on dividends in the new regime reduce the NAV of the mutual fund scheme.
- The dividend received by the investor is net of the tax, resulting in a lower NAV.
- Benefits of the growth option:
- Growth option in mutual funds is more tax-efficient.
- Mutual fund schemes are tax-exempt, and capital gains are realized only when booked.
- Allows for deferment of taxes and takes advantage of compounding before tax.
- Changes from April 1, 2021:
- Mutual funds declaring dividends need to indicate the amount attributed to income distribution and capital distribution.
- Tax calculation should be made based on this segregated basis.
STAMP DUTY ON MUTUAL FUND UNITS
- Applicability of stamp duty:
- From July 1, 2020, stamp duty is applicable to mutual fund units issued against purchase transactions.
- Stamp duty is also applicable to transfer of mutual fund units between demat accounts.
- Stamp duty rates:
- Purchase transactions: Stamp duty is levied at 0.005% of the amount invested.
- Transfer of units: Stamp duty is levied at 0.015% of the transferred units.
- Notification and regulations:
- Stamp duty on mutual fund units is governed by notifications issued by the Department of Revenue, Ministry of Finance, and Legislative Department, Ministry of Law and Justice, Government of India.
- The relevant notifications are:
- Notification No. S.O. 4419(E) dated December 10, 2019
- Part I of Chapter IV of Notification dated February 21, 2019
- Notification dated March 30, 2020
Note: Stamp duty rates and regulations are subject to change as per the prevailing laws and government notifications.
SETTING OFF OF CAPITAL GAINS AND LOSSES
- Income Tax Act provisions:
- Income Tax Act categorizes income under different heads, including capital gains.
- Losses in one head of income can be set off against gains in the same head, subject to certain limitations.
- Set-off limitations for capital gains:
- Capital losses (short-term or long-term) cannot be set off against other heads of income, such as salaries.
- Short-term capital losses can be set off against short-term or long-term capital gains.
- Long-term capital losses can only be set off against long-term capital gains.
- Limitations on setting-off in mutual funds:
- Bonus Stripping: Capital losses from selling units after a bonus issue may not be available for setting off against capital gains.
- If the original units were bought within 3 months prior to the bonus record date and sold within 9 months after the record date, the capital loss is treated as the cost of acquisition of the bonus units.
Note: Other factors and provisions may also affect taxation and tax exemptions. Consult a tax professional or refer to the Income Tax Act for complete details.
SECURITIES TRANSACTION TAX (STT)
- Applicability of STT:
- STT is applicable when selling units of an equity fund on the stock exchange or offering them for repurchase to the fund.
- STT is applicable only on redemption/switch to other schemes/sale of units of equity-oriented mutual funds.
- STT is not applicable on the purchase of units in an equity scheme or transactions in debt securities or debt mutual fund schemes.
- STT rates and payable by:
- Purchase of units of equity-oriented mutual funds: Nil (payable by the purchaser).
- Sale of units of equity-oriented mutual funds (delivery-based): 0.001% (payable by the seller).
- Sale of equity shares, units of business trust, units of equity-oriented mutual funds (non-delivery-based): 0.025% (payable by the seller).
- Sale of units of an equity-oriented mutual fund to the mutual fund: 0.001% (payable by the seller).
Note: The rates mentioned are subject to change as per prevailing tax laws and government notifications
TAX BENEFIT UNDER SECTION 80C
- Equity Linked Savings Schemes (ELSS):
- ELSS is a type of mutual fund scheme eligible for deduction under Section 80C of the Income Tax Act.
- ELSS schemes invest in equity shares and have a lock-in period of three years.
- The tax benefit is available up to Rs. 1.50 lakh per year per taxpayer for individuals and HUFs.
- Sharing the Section 80C limit:
- The Section 80C limit is to be shared across eligible investment avenues.
- If the limit is exhausted through other investments, additional investment in ELSS will not receive additional tax exemption.
- However, the investment in ELSS remains locked-in for a minimum of three years.
- Lock-in period for SIP and reinvested dividends:
- In the case of SIP investments, each installment is locked-in from its respective investment date.
- If opting for (dividend) Income Distribution cum capital withdrawal reinvestment plan, each reinvested dividend also attracts a 3-year lock-in.
- Most AMCs now offer only the growth option or dividend payout for ELSS.
- Tax benefit and joint holding:
- The tax benefit under Section 80C is available to the first holder in case of joint holdings.
- Parallel tax structures:
- The Union Budget 2020 introduced a parallel tax structure with lower rates and different exemptions and deductions.
- Those opting for the new regime would not be eligible for the tax-saving benefit under Section 80C for ELSS investments.
- Retirement-oriented funds:
- Some retirement-oriented funds offer Section 80C benefit with a lock-in period of 5 years.
- These funds aim to accumulate a corpus for an individual's later years.
- Not all retirement funds have this Section 80C benefit, so it is essential to check the specific fund's eligibility.
Note: Tax laws and regulations are subject to change. Investors should consult a tax professional or refer to the Income Tax Act for the most up-to-date information.
Understanding the tax benefit under Section 80C helps investors plan their tax-saving investments effectively and maximize their tax benefits.
TAX DEDUCTED AT SOURCE (TDS) AND APPLICABILITY OF GST
- TDS on re-purchase proceeds:
- There is no TDS on re-purchase proceeds for resident investors.
- However, certain cases of non-resident investments may attract TDS.
- TDS rates vary based on the nature of the investor, nature of investment, and nature of income (dividend/capital gain).
- TDS on dividends from mutual fund schemes:
- TDS is applicable even for resident Indians on dividends from mutual fund schemes.
- TDS is deducted at a rate of 10% if the dividend amount exceeds Rs. 5,000.
- Double Taxation Avoidance Agreements (DTAA):
- India has DTAA with several countries, specifying rates for withholding tax.
- For non-resident investors, TDS is the lower of the rates specified in income tax regulations or the DTAA of their resident country.
- The investor must provide sufficient information and documents to avail the concessional rate specified in the DTAA.
- Applicability of GST:
- Asset Management Companies (AMCs) can charge GST to schemes within the prescribed limits under SEBI (Mutual Fund) Regulations.
- GST is charged on investment management and advisory fees in addition to the overall Total Expense Ratio (TER) provisions.
- Other fees, excluding investment and advisory fees, are subject to GST within the maximum TER limit.
- GST on exit load is deducted from the load amount, and the net amount is credited to the scheme.
- GST on brokerage and transaction costs for trade execution is within the TER limit.
- GST on commission payable to distributors may apply as per the applicable tax laws but cannot be charged to the scheme.
Note: Tax rates, TDS provisions, and GST regulations are subject to change as per prevailing laws and government notifications.
Understanding the implications of TDS and GST helps investors and AMCs comply with tax regulations and ensure proper tax deductions and payments.