TAXATION

Introduction:
When anyone considers making an investment, one of the objectives is to get some
investment returns. However, such returns on investments or income from
investments may be subject to tax. The investor would get the income after the
payment of taxes. In such a case, it is important to understand the taxation
associated with one’s investments.

Applicability of taxes in respect of mutual funds:

Income from investment in mutual fund units

• Investors must consider the effect of taxes on their investment returns. It is
not how much you earn, but how much you keep after taxes that counts.
• As a mutual fund is a pass-through vehicle, we must consider the income at
two levels–
a. income earned by the fund
b. income earned by the investor

Income earned by mutual fund schemes:

• The schemes of the mutual funds invest in marketable securities like shares
and debentures.
• These securities generate income in the form of dividend or interest. Apart
from this, when the fund buys and sells the shares and debentures in the
securities market, there could be capital gains or losses. Interest, dividend
and capital gains form the income of the mutual fund.
Note: As per the prevailing tax laws in India, a mutual fund’s income is exempt
from income tax, since mutual funds are constituted as trusts in India for the
benefits of the unitholders. Section 10(23) (D) of the Income Tax Act exempts all
the income earned by the mutual fund schemes from any tax.
Income earned by the investor from investment in mutual fund units:
• We have already seen that the investor can choose from two options within
the scheme, viz. (earlier called Dividend) Income Distribution cum capital
withdrawal option and growth.
• The one who has opted for Income distribution cum capital withdrawal
(dividend) may get income in form of dividends, whereas the investor in the
growth plan would not get any dividend whatsoever, irrespective of the
profits earned by the fund.
• The investor in the growth plan would earn capital gains (or losses)
whenever one sells the units of the scheme. On the other hand, the investor
in the Income Distribution cum capital withdrawal (dividend) plan may get
dividend, as and when declared by the fund, as well as capital gains (or
losses) when one sells the units.

Capital Gains

• When a unitholder sells units of the scheme, the selling price could be
different from the price at which the units were bought.
• The difference between the purchase price of the units and the selling price
of the units would be treated as capital gain (or loss).
• If the selling price is higher than the purchase price, there is an incidence of
capital gain, whereas if the selling price is lower than the purchase price,
there is a capital loss.
• The capital gains are subject to tax.
• Capital gains tax is classified depending on the period of holding and the
type of funds invested in.
Capital gains are classified into two categories:

Capital Gain

Equity Scheme Debt Scheme (Non-Equity)

Long Term Short Term Long Term Short Term
More than Less Than More than 36 Less than 36
12 months 12 months months months
*LTCG - 10% LTCG-20% with
STCG-15%
1 lakh indexation STCG-30%
no exempt
exempt benefit
*LTCL STCL Not Applicable *LTCL STCL
*Note: Exemption up to Rs. 1 lakh: In case of long term capital gains arising out
of equity shares and equity-oriented mutual funds, the tax is applicable only on
the capital gains above Rs. 1 lakh.

➢ Long Term Capital Gains

➢ Short Term Capital Gains

Equity-oriented Non-equity-oriented
Capital Gain
funds funds
More than equal to 1 More than equal to three
Long term capital gains
year years

Short term capital gains Less than 1 year Less than three years
 ➢ Long-term is defined as a holding period of more than three years in case
of non-equity- oriented funds, whereas the same is more than 1 year in case
of equity-oriented funds.

➢ Short-term is defined as a holding period of less than three years in case

of non-equity- oriented funds, whereas the same is less than 1 year in case of
equity-oriented funds.

Note: Non-equity-oriented funds such as Debt, Liquid,

overnight and other debt-oriented fund.

Capital Gains Tax

Equity-oriented
Capital Gain funds
Non-equity-oriented funds

Long term capital gains 10 percent 20% with indexation benefits

Short term capital Marginal tax rate, as

15 percent
gains applicable for the investor

Note:
1. Long Term Capital Gains on equity-oriented fund is to be taxed at 10% on
gains greater than 1 lakh without indexation and subject to payment of STT.

2. Long term capital gains on non-equity-oriented funds: After providing

indexation benefit in respect of cost of acquisition.
What is indexation?
Watch YouTube video - https://youtu.be/KKlsYoSaKAs

Setting off of Capital Gains and Losses under Income Tax Act

• The Income Tax Act provides for taxation under various heads of income
viz. salaries, income from house property, profits & gains of business or
profession, capital gains, and income from other sources.
• In the normal course, one would expect that a loss in one head of income can
be adjusted (set off) against gains in another head of income, since a person
is liable to pay tax on the total income for the year.
• However, there are limitations to such set-off. A few key provisions here
are:

➢ Capital loss, short term or long term, cannot be set off against any other head
of income (e.g., salaries).

➢ Short term capital loss is to be set off against short term capital gain or
long- term capital gain.

➢ Long term capital loss can only be set off against long term capital gain.
Dividend income
• Dividend income from mutual funds used to be tax-free in the hands of the
investor. There was no tax payable at all, irrespective of how much dividend
one earned.
• However, the dividend would be paid to the investor after the deduction of
dividend distribution tax from the scheme itself.
• In the Union Budget presented by the finance minister in February 2020, the
situation changed.
• The dividend distribution tax has been done away with, whereas the
dividend would henceforth be added to the taxable income of the assesse for
the year.
• This means the dividends would be taxable in the hands of the recipient at
the applicable tax rate.

Stamp Duty on Mutual Fund Units

With effect from July 1, 2020, mutual fund units issued against Purchase
transactions (whether through lump-sum investments or SIP or STP or switch-ins
or Reinvestment of Income Distribution cum capital withdrawal option would be
subject to levy of stamp duty* @ 0.005% of the amount invested.
Box 8.2 provides some more details regarding stamp duty on mutual fund units.
Securities Transaction Tax

• When an investor sells units of an equity fund in the stock exchange, or

offers them for re- purchase to the fund, he will have to incur Securities
Transaction Tax (STT)

• STT is applicable only on redemption/switch to other schemes/sale of units

of equity oriented mutual funds whether sold on stock exchange or
otherwise.

STT applicability for Investors in Equity oriented Mutual funds

Transaction Rates (in percent) Payable by

Purchase of units of equity oriented
NIL Not applicable
mutual fund

Re-purchase/Sale of units of equity

0.001% Investor
oriented mutual fund (delivery based)

Transactions in debt securities or debt

NIL Not applicable
mutual fund schemes
Tax benefit under Section 80C of the Income Tax Act
Certain mutual fund schemes, known as Equity Linked Savings Schemes (ELSS)
are eligible for deduction under Section 80C of the Income Tax Act. As the name
suggests, this is an equity- linked scheme, and hence the scheme invests in equity
shares. The benefit is available up to Rs. 1.50 lacs per year per taxpayer in case of
individuals and HUFs. The scheme has a lock-in period of three years from the
date of investment.

What is ELSS? Why to invest in ELSS Funds?

• ELSS or Equity Linked Savings Schemes are Mutual fund investment
schemes that help you save income tax.
• That’s why they are also known as tax-saving funds. The Income Tax Act,
under section 80c, allows taxpayers to invest up to INR 1.5 lakh in specific
securities and claim it as a deduction from their taxable income.
• One of the approved securities is ELSS– others include PPF, postal savings
like NSC, tax-saving FDs, NPS, etc.

Features of ELSS Mutual Funds

Here are some of the key features of an ELSS fund
1. ELSS funds invest a large percentage of their portfolio in equity.
2. They have a compulsory lock-in period of 3 years, which is the shortest
amongst all tax saving instruments.
3. You enjoy the dual benefits of capital appreciation from investments in
equity along with tax-saving.
4. You can opt for dividend pay-outs if you wish to receive regular income or
go with the growth option for capital appreciation.
5. ELSS Mutual Funds do not have any entry or exit load.
6. Good ELSS Funds generate returns in the range of 10-12 per cent in the long
run, among the highest in the tax-saving category of instruments. However,
ELSS also comes with some risk, inherent in equity investments.
How to invest in ELSS
• You can invest in ELSS the same way that you invest in any Mutual Fund.
The easiest way is through an Online Investment Services Account. You can
invest either as a lump sum or via the SIP (systematic investment plan)
route.
• SIP ensures regularity and discipline and reduces the risk to capital
• You can invest as little as INR 500 in an ELSS fund
While you can claim tax benefit only up to INR 1.5 lakh, you are free to invest as
much as you like.

How does ELSS compare with other Tax Saving instruments?

Tax on
Name of Instrument Lock In period
Returns
ELSS 3 Years LTCG Tax
Tax-Saving FD 5 years Income Tax
National Saving Certificate (NSC) 5 years Income Tax
Public Provident Fund (PPF) 15 years No
Partially
National Pension System (NPS) Up to age 60
Taxable

For more detail on ELSS

Watch YouTube video - https://youtu.be/GB6GfXA0WiM

Tax Deducted at Source
• There is no TDS on re-purchase proceeds to resident investors.
• However, for certain cases of non-resident investments, the same is
applicable.
• In Budget 2020, DDT is abolished, and AMC is only required to deduct
TDS at 10% on the distribution of dividends, provided that the dividend paid
per recipient exceeds Rs. 5,000 in an FY.
• In case of dividends from mutual fund schemes, even for resident Indians,
TDS is applicable.

➢ Often, NRIs have a question; can NRI invest in a mutual fund?

Well, the answer is yes, NRI can invest in a mutual fund. For an NRI to make
investments in mutual funds in India, the person needs to open an NRE (Non-
Resident External) account or an NRO (Non-Resident Ordinary) account, or an
FCNR (Foreign Currency Non-Resident) account.

Understanding the NRI Mutual Funds Taxation:

Chapter 8: Sample Questions:

1. What is the tax applicable on the income earned by the mutual fund schemes?
a. It is a function of the type of income since dividends, short term capital gains and long-term
capital gains attract different tax rates
b. Income earned by a mutual fund is exempt from taxes
c. 10 percent plus surcharge and cess
d. It is a function of the marginal rate of tax applicable to the respective investor in the mutual fund
scheme

2. Redemption from which of the following mutual fund schemes would attract Securities
Transaction Tax (STT) for an investor?
a. Multi-cap mutual fund
b. Government Securities Fund
c. Liquid Fund
d. Overnight Fund

3. In the non-equity-oriented funds, the rate of long-term capital gains tax is.
a. 10 percent with indexation
b. 10 percent without indexation
c. 20 percent with indexation
d. 20 percent without indexation

4. In case of capital gains from mutual fund investments, Tax Deduction at Source (TDS) is
applicable for:
a. Minor through guardian
b. Non-Resident Indians (NRIs)
c. All investors, who have invested more than Rs. 5 lacs
d. TDS is not applicable in case of mutual funds

5. The Income Tax Act allows setting-off of the short-term capital loss against long term capital
gains. State whether True or False.
a. True
b. False
6. DDT has been abolished from MF industry post feb'2020
a. True
b. False

7. STP is combination of SIP+SWP

a. True
b. False

8. When the interest rate in the economy decreases, the price of existing bonds?
a. Decrease
b. Increases
c. No Change

9. When the interest rate in the economy increases, the price of existing bonds?
a. Decrease
b. Increases
c. No Change