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Tax Benefits of Mutual Fund Investments

Tax Benefits of Mutual Fund Investments

Tax Benefits of Mutual Fund Investments

A mutual fund is a system of investment wherein funds are collected from the public and invested in specified securities on behalf of the investors. Mutual funds provide investors with varied options for investment, together with hybrid combinations of debt and equity. Mutual funds are classified into two forms, namely equity mutual funds and debt mutual funds. Mutual fund investments are encouraged by the government through various tax benefits. In this article, we briefly discuss the various tax benefits of mutual fund investments in India.

Holding Period for Mutual Funds

Mutual funds can be held on a long term and short-term basis. The time period for short term equity-oriented mutual funds is less than a year, whereas it is less than three years for non-equity-oriented or debt funds. On the other hand, the holding period for long term equity-oriented mutual fund is a year or more, while non-equity oriented funds are held for more than three years.

Section 80C Deduction

The amount invested in equity-based investments can be claimed as a deduction under Section 80C. Under this section, a total sum of Rs. 1,50,000 will be allowed as a cumulative deduction in a particular year. Investments in PPF account, EPF account, pension plans such as National Pension System, deposits in a life insurance policy, payments of tuition fees, national savings certificate, Equity Linked Saving Scheme (ELSS), Senior Citizens Savings Scheme (SCSS), tax-saving fixed deposit, Unit Linked Insurance Plans (ULIP), Sukanya Samridhi Yojana, repayment of home loan, are some of the most prominent instruments for which deductions can be claimed under this section. Deduction under Section 80C is applicable for Individuals and HUFs. The lock-in-period of equity mutual funds that can be claimed as deductions under this section is stipulated to be three years, which effectively implies that equity mutual funds are not transferrable for a span of three years.

Exemptions on Dividends

Dividend Distribution Tax (DDT) refers to the income tax paid by a company on the dividends distributed to members. Dividends received by the investors out of their investments in equity mutual funds will not be taxable in their hands. There was no specified limit for deductions until the financial year of 2016-17, after which it was restricted to a sum of Rs. 10 lakhs. Dividends above this limit will incur a tax rate of 10%. Mutual funds other than equity will incur a tax rate of 25%, which will be added with a surcharge of 10% and 3% of cess. Taxpayers should be aware that in the Union Budget presented on 1st February 2020, the Finance Minister announced that with effect from 01.04.2020, DDT would not be applicable. Hence, tax on dividends would be paid by the individual investors. Thus, the Government has shifted the burden of dividend-taxation from companies to individuals.

Capital Gains Tax on Sale of Mutual Funds

Mutual fund profits are classified into Long Term Capital Gains (LTCG) and Short Term Capital Gains (STCG). Gains occurring out of the sale of mutual funds are exempted from capital gains tax if the equity mutual funds are held for more than a year. No maximum limit has been specified for these exemptions from income-tax. Funds held for less than a year would be imposed at a discounted rate of 15% under Section 111A. If the STCH falls below the taxable amount, such STCG will be reduced by the amount of shortfall. However, no limit has been specified for the quantum of investments an investor can make. The maximum amount of withdrawal is determined by the Net Annual Value (NAV) and the company offering the fund. Also, investors should understand that subscribers to a mutual fund are not deprived of the facility of switching their funds to another account but are only entitled to transfer a part of their investments.