How do you determine the tax rate on mutual funds? Being regulated by Securities and Exchange Board of India (SEBI) and the Association of Mutual Funds in India (AMFI), mutual Fund companies are regulated and supervised by these government agencies. The license to run a mutual fund company needs complete due diligence as bank licenses are only allowed to be issued after adherence. To brief it up, a mutual fund company is just as safe as an ordinary bank. The attached risks are fully minimized.
Mutual funds are basically meant to reap higher, tax-efficient returns. Taxes are required to be paid on the capital gains or profits earned from mutual funds. The capital gains earned is the base for mutual fund taxation. If at all, dividends are earned from mutual funds, then Dividend Distribution Tax (DDT) is subtracted from the dividend paid. However, taxation rate differs according to the chosen fund type.
Let us understand, capital gains based mutual fund taxation:
A capital gain can be portrayed as the difference between the purchase value and sale value. For example, if someone has invested Rs.1 lac into a mutual fund, and if now its valued at 1.5 lacs, then Rs,50000 is called the capital gains. This taxation amount will be applicable if the units are sold. There is no tax on unrealized or accrued amount. The taxation will also depend on how long you have held the fund and what is the nature of it. The mutual funds taxation depends on how long you have held the fund and what type of fund it is.
Capital Gains: Exemptions: Long term capital gains on equity investments are exempt upto 1 lac annually.
Earlier no long term capital gains on equity was applicable. However, budget 2018 introduced 10% tax on long term gains, exempting gains before 1st February 2018.
Adjustment against Capital Gains: It is allowed to adjust gains in one fund against losses in another in the same year, if both are same termed. Meaning to say that long term gains can only adjusted against short term losses. Equity fund dividends are taxed at 10% and non-equity fund dividends are taxed at 28.84%. In both the situations, DDT is deducted before distributing the dividend. Hence, no additional tax is payable.
Coming to the second type of safety, it is true that Mutual Funds don’t guarantee capital protection or fixed returns. But that is a good thing because Mutual Funds would be poor investment products if they did.
The purpose of investing in Mutual Funds is to generate higher returns than what traditional investments offer. Mutual Funds are also more tax-efficient than traditional investments. Short-term as well as long-term gains from Mutual Funds are taxed in a way that it doesn’t eat into the returns. This is why, Mutual Funds don’t guarantee returns, but they still make a lot of sense as long-term investments because the longer you stay invested in them, the more returns you earn. This is because of the power of compounding where your returns also earn returns. Over most long periods, Mutual Funds have given superior returns that have beaten traditional investments and also been higher than the prevailing rate of inflation. The risk that comes with Mutual Fund investments can be managed by diversifying your investments.