Melvin Joseph of Finvin Financial Planners explains the applicability and calculation of taxes on different fund categories.
When you allocate investments for long term financial goals, taxation will make lot of difference on your client’s corpus accumulation. If they are getting it tax free like PPF, it is always good.
Let us see how to calculate tax on mutual funds. First of all let us study what are the heads under which we get income from mutual funds. If your client’s investment is in growth option of the mutual fund, the gain will be reflected by way of increase in net asset value (NAV). This gain is called the capital gain. But, if they have opted for dividend option, the gain will be by way of periodic dividend also.
Let us see how to calculate tax on mutual funds under these two heads.
How to calculate capital gain tax on mutual funds?
1. Equity mutual funds
For taxation purpose, funds with 65% or more allocation in equity are classified as equity funds. So balanced funds like HDFC Prudence, HDFC Balanced etc. also will come under this category.
Suppose you have invested 1 lakh in Feb. 2005 in HDFC Prudence fund. The value of this investment is around 4 lakhs today. How much is the capital gain? It is 4 lakhs – 1 lakhs = 3 lakhs. You want to sell this fund today for buying a car. How to calculate tax payable in this scenario?
Here is the good news. You need not pay any tax on this gain of 3 lakhs. This is because the long term capital gain from equity mutual fund is tax free.
What is long term capital gain?
It is the gain you are getting, when you are selling the mutual fund after 365 days of its purchase. As per the current tax rules, long term capital gains from equity mutual funds are tax free.
What is short term capital gain?
It is the gain you are getting, when you are selling the mutual fund within 365 days of its purchase. As per the current tax rules, you have to pay 15% tax on the short term capital gains from equity mutual funds. With 3% cess, it will be 15.45%.
2. Debt mutual funds
In addition to normal debt funds, funds with less than 65% in equity, international funds, gold funds, fund of funds etc. are also considered as debt funds for taxation purpose.
In debt funds, the short term capital gains are fully taxable. You have to pay tax as per your tax slab. Suppose you are getting Rs 30,000 as short term gain by selling a debt fund within 1 year and if your salary income is 4 lakhs, your taxable income will be 4, 30,000.
For long term capital gains in debt funds, you have to pay tax as follows
- 20% with indexation benefits or
- 10% without indexation benefits.
What is indexation?
Indexation helps you to offset your gain with the effect of inflation. Government will notify the cost of inflation index every year. Please note the cost of inflation index for the recent 3 financial years.
2010-11: 711, 2011-12: 785, 2012-13: 852
Let us see how to calculate capital gain for debt funds?
Suppose you have invested 1 lakh in a debt fund in January 2011 and are selling in Feb. 2013 for 1, 20,000.
Your original investment = 100000
Indexed cost: 1, 00,000 x 852/711 = 1, 19,831.
Capital gain after indexation = 1, 20,000 – 1, 19, 831 = 169/- (sale price- indexed cost)
So, in this case, you have to pay 20% tax on the gain of Rs 169 only and not on the gain of 20,000! Your tax liability is only 34/-. This is the benefit of indexation.
If you don’t want to apply indexation, you have to pay 10% tax on the gain of 20,000. Then the tax liability will be Rs 2000.
How to calculate tax on mutual funds dividend income?
1. Equity mutual funds
There is no tax on mutual funds dividend you receive from equity mutual funds. It is tax free in your hands.
2. Debt mutual funds
You need not pay any tax on mutual funds dividend you receive from debt mutual fund. But the mutual fund company is liable to pay dividend distribution tax to the government before paying the dividend to you.
Dividend distribution tax in debt mutual funds (DDT)
For liquid funds and money market funds, the DDT is 25%. There is another 5% surcharge on it along with 3% cess. So, the effective rate of tax will be 27.0375 %( 25% tax+ 5% surcharge+3% cess).
In other debt funds, the DDT rate is lower. It is 12.5 %. There is another 5% surcharge on it along with the 3% cess. So, the effective rate of tax will be 13.5188%.
Will they deduct tax on mutual funds income?
No, the fund house will not deduct the tax from your gain. You have to calculate and pay tax on mutual fund income. But for NRIs, tax on mutual funds will be deducted as per the applicable rates before paying.
So how are mutual fund investments more tax-efficient?
Here, you pay tax only at the time of redemption. But in bank deposits, you have to pay tax every year on accrual basis. With indexation benefits, debt funds are more attractive than fixed deposits. Equity funds after one year are totally tax free.
Hope that this article was useful in understanding the tax on mutual funds.
The article was first published on http://www.finvin.in
The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.
