Many have started investing in mutual funds with growing awareness as they tend to give better returns compared to other investment options. However, one should know that income gained on mutual funds are taxed. It is important to know how the tax system works when it comes to mutual funds. The main thing one should keep in mind is that the duration of the investment is important when it comes to tax deductions in mutual funds.
Here, let us see how taxation works in mutual funds.
People invest in equity funds keeping in mind long term goals, i.e., for 5-7 years. However, if you withdraw within 1 year, then gains on the invested sum, called as short term capital gain, will be taxed at 15 per cent. If the mutual fund units are withdrawn after 1 year, then returns are taxed at 10 per cent. The returns that are earned after a minimum investment of 1 year are called long term capital gains.
Note: Here, only capital gained is taxed but not the principal amount. Let us see this with an example.
Say, X made an investment of Rs 50,000 in mutual funds and his money grew to Rs 1,00,000 in 3 years. X decided to take away Rs 50,000. That means, he is taking Rs 25,000 principal amount and Rs 25,000 appreciation amount. Hence, only the appreciation sum is taxed, i.e., the tax has to be paid only on Rs 25,000.
Balanced funds are taxed in the same way as equity funds. 15 per cent is taxed on the short term capital gains and 10 per cent on the long term capital gains.
Debt fund investment fulfils short term goals. Unlike equities, debt funds are taxed according to the income tax slabs. If debt fund units are sold before 3 years, they will be taxed according to the income tax slabs. If sold after 3 years, 20 per cent tax is imposed on gains.
How the tax works in the case of SIP (Systematic Investment Plan)
In SIP, each invested amount is considered as a fresh sum. For instance, say a person has invested in SIP every month for 1 year in equities. Now, he wants to sell his mutual fund units after a year. If he sells his units, the income gained on the first SIP is taxed at 10 per cent and income gained from the remaining 11 SIPs will be taxed at 15 per cent because those 11 SIPs have not completed a year and are considered as short-term capital gains.
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