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Gains from any investments are taxed including that from mutual funds. This article helps you to calculate the tax liabilities arising from your mutual fund investments
Taxes,
like death, are an inescapable part
of an investor’s
life. With your mutual fund investments too, if you don’t pay
attention to
taxes, they might kill off a good part of your gains. The taxation
rules for
shares and simple derivatives are very straightforward but when it
comes to
mutual funds, a little more attention is required. There are different
taxation
rules for equity and non-equity mutual funds. This article explains the
basic
rules for an individual or Hindu Undivided Family (HUF) investor Dividends All
dividends, declared by equity or
non-equity mutual funds
are tax-free in your
hands
but a Dividend Distribution Tax (DDT) is to be paid by the mutual fund
house on
the dividends they declare on their debt funds. There is
no DDT paid by the mutual fund on
dividend declared by equity mutual funds. Dividend Stripping Capital
gains are calculated on mutual fund
investments as
well. In cases where dividends are paid, the tax authorities first
determine
whether the investor remained invested in the mutual fund 3 months
before and 9
months after the dividend declaration. If not, the tax authorities will
add up
the dividend and the redemption amount to decide a capital loss or
gain. This especially
affects a practice called “Dividend Stripping”
where
investors incur a capital
loss on investments due to the payment of dividends. Let’s
take
an example. Suppose,
on 1 January you invest into a
mutual fund, with the
NAV at Rs20. On 30 January the NAV rose to Rs21 and on 31
January,
the fund declares a dividend of Rs3 per unit. So the NAV on 31
December
is Rs18, assuming there is no change in the markets. You decide to
redeem your
units on 1 February
when the NAV is Rs18, again assuming no
change
in the markets. It
would seem that you have incurred a
capital loss of Rs2 per
unit; although you have received a dividend of Rs3 per unit, you have
incurred
a capital loss of Rs2 per unit in the sale. The practice is called as
dividend
stripping. However,
in this example, the tax
authorities will add up Rs18
(the redemption amount) and Rs3 (the dividend) and subtract it from
Rs20 (the
initial investment), which leads to a gain of Rs1 per unit - this money
is
liable to be taxed. It is important to bear in mind that this rule is
applicable
on all dividend-paying mutual funds. Short-term and Long-term
Capital Assets and Gains Under
Section 2(42A) of the Income Tax Act,
a unit of a
mutual fund is treated as short-term capital asset if held for less
than 12
months. Units held for more than twelve months are treated as long-term
capital
assets. Hence, if you buy units of a mutual fund on 1 January 2008 and
if you
sell the units on 1 January 2009 or earlier, the gains from the
investment come
under the purview of short-term capital gain tax rules. Suppose you
redeem the
fund units on 2 January 2009, then the gains from the investment come
under the
purview of long-term capital gain tax rules. Taxes and Equity
Mutual Funds Taxation
rules on equity mutual funds are
relatively simple.
For taxation purposes, a mutual fund is considered an equity mutual
fund if its
portfolio consists of at least 65% of equity and equity-related
instruments. Short-term
capital gains on equity mutual
funds are taxed at
15% (plus education cess, applicable surcharge).There is no long-term
capital
gains on equity mutual funds. Taxes and Non-equity
Mutual Funds Non-equity
mutual funds are debt funds and
fund of funds
which invest outside Dividend Distribution
Taxes on Non-equity Mutual Funds The
Dividend Distribution Tax (DDT) for non
Liquid/Money
market funds (debt funds and Fund of Funds) is 14.163% (12.50% + 10%
surcharge +
3% education cess). The dividend distribution tax for Liquid/Money
market funds
is 28.325% (25% + 10% surcharge + 3% education cess). The DDT is paid
by the
fund before distributing the dividends. Short-term Capital
Gains on Non-equity Mutual Funds The
short-term capital gains on non-equity
mutual funds are
added to your total taxable income and the tax is deduced from the
suitable
slabs. The tax slabs for Men, Women and Senior Citizens are as follows:
To explain short-term capital gains taxes on non-equity mutual funds consider the following scenario: A male, aged 40 and earning Rs400,000 per year makes a capital gain on debt mutual funds of Rs50,000. The income considered for income tax computation will be Rs400,000 + Rs50,000 = Rs450,000. So, for the initial Rs160,000, he pays no tax, then from the Rs160,001 to Rs 300,000 he pays 10% as tax i.e. 10%
of (Rs300,000 - Rs160,001) = 10% of Rs 140,000 = Rs 14,000. He
then pays 20% tax for income between Rs 300,001 to Rs450,000. 20%
of (Rs450,000 - Rs300,001) = 20% of Rs150,000 = 30,000. In
total, the man pays Rs44,000 plus applicable surcharges
and education cess in taxes. Long-term Capital
Gains on Non-equity Mutual Funds In
case of Long-term Capital Gains, you
have two options of
calculating the tax: Option
1: 10% without indexation (plus surcharge of 10%) Option
2: 20%
with indexation
(plus surcharge of 10%) You
have to pay the lower of the two values
as calculated above. Let
us consider the following situation; an investor invests into the
growth option of a debt fund Rs100,000 on 1 April 2005, and redeems the
investment
on 30 April 2007 for Rs130,000. The investor has made long-term capital
gains
of Rs30,000. Under
option 1,
the investor needs
to pay 10% of Rs30,000 = Rs3000
as long-term capital gains tax Under
option 2,
we need to use the Cost Inflation Index
(CII) values released by the Income Tax department every year. The
recently
released CII for 2009 is available here The formula used for calculation is: Long-term
Capital Gains = Redemption Amount - Indexed
capital Investment Long-term
Capital Gains = Rs130,000 – Rs110,865.2 = Rs19134.8 Tax
on Long-term Capital Gains = 20% of Rs19134.8 = Rs3826.96 The
investor needs to pay Rs3826.96 as the long-term capital
gain tax under option 2. The
investor will pay the lower of Rs3000 and Rs3826.96 i.e.
Rs3000 as the Long-term Capital Gain Tax. Until the new proposed tax code comes into effect, the above mentioned rules and regulations can be used by mutual fund investors to calculat taxes on mutual fund investments. |
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Manjunath Gaddi is part of iFAST Financial India Private Ltd. | ||||||||||||||||||||||||||||||||||||
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iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website. | ||||||||||||||||||||||||||||||||||||
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