Hey everyone let’s talk about the taxation on mutual funds.
first let’s think of mutual funds split into 2 broad categories:-
1)Equity and equity oriented funds.
2)Debt and debt oriented funds.
To give you a deeper insight into what all come under equity and equity oriented funds so one obviously we have all types of equity funds large, mid, small, sectoral so on and so forth apart from that we have any fund which has a composition of equity above 65% so this could include balanced funds, wherein the mandate itself says it needs to have 65% and above invested into equity stocks, also it includes arbitrage as a category, so while arbitrage is done between equity stocks this is also considered as a part of equity when it comes to computing taxation now talking about debt and debt oriented funds one it obviously includes all debt fixed income funds along with that it includes fund of funds as well, so fund of funds is typically an Indian Mutual fund where in it invests money into another mutual fund which could be Indian or non Indian, so such a synthetic structure is also categorised as debt when it comes to taxation although its underlying securities might be equity now lets take a deeper look into how is each one of these taxed.
1) EQUITY AND EQUITY ORIENTED FUNDS
Lets talk about the taxation on equity and equity oriented funds first so the taxation can be split into 2, taxes on short term capital gains and taxes on long term capital gains so the short term period for equity is one year if you redeem within a period of 1 year and you book a profit that profit is subject to 15% of tax now lets say you redeem and make a gain after holding for a period of over one year that gain component is subject to a tax at 10% on gains over and above Rs.100000 for a particular financial year, for example, lets say you invest Rs.100000 and by the end of one and a half year its value goes up to 2.5 lakhs you need to pay in taxed that is 10% only on 50000 which is over and above the 1 lakh rupee gain.
2) DEBT AND DEBT ORIENTED FUNDS
so lets take a look at the taxation on debt and debt oriented mutual funds so once again we split it into tax on short term capital gains and tax on long term capital gains the difference here is unlike equity the term that qualifies as a short term is a period less than 3 years and not 1 year and the long term is obviously the term over and above 3 years , so the short term capital gains suggest that if you book a profit after selling a debt investment within a period less than 3 years it will be taxed as per your personal tax rate and if you happened to hold the investment for over and above 3 years then the profit that you make is subject to a tax of 20% with an indexation benefit .
WHAT IS INDEXATION?
since we know that the long term capital gain tax on debt funds is 20% with an indexation benefit it only makes sense that we understand more about indexation as a concept.
so to be honest indexation calculation is quite convoluted in nature but let me try to simplify it through a simple example now here is the premise okay so lets assume that today 1 kg dal costs Rs.100/kg and lets say 3 years down the line the same 1 kg of dal is going to cost you Rs.150 now just hold onto this, lets move ahead so let’s assume today you invest Rs.100 on a debt fund and over a period of 3 years the value of this Rs.100 go up to Rs.180 at the end of 3 years now as per normal taxation the game portion that is the current value that is Rs.180 minus your invested value of 100 which comes upto Rs.80 should be taxed because that is your gain. But here is the benefit that the government of India has allowed investors to avail so the government says or rather the Income Tax department says 3 years back Dal would have cost you a Rs.100 but now it is costing you a Rs.150 because of inflation so your real gain from 100 is not to 180 because money at the end of the day is nothing but purchasing power so when dal went up from 100 to 150 and your investment went up from 100 to 180 the Rs.50 of that gain portion can be attributed as an inflation component so gains only over and above the inflation that is 180-100-50=Rs30 would be subject to a tax of 20% thats is Rs.6 so here is a brief overview of how indexation works the calculation is obviously a topic for another day it has quite a lot of metrics into place.