How are mutual funds taxation? - Part I

How are mutual funds taxation? - Part I

by Mutual Fund Research Desk

If there is one detail regarding investment that everyone pays close attention to, it is taxation.

Here’s putting down what you need to know about taxes and your funds.

While much of your other income, like salary or / interest income, is taxed at your slab rate (10%, 20%, 30%), the gains you receive from mutual funds – called capital gains – have separate taxation provisions.

They are called capital gains tax. Since taxation is a vast topic, even while considering only mutual funds, we will cover it in 2 parts.

What is MF capital gain?

Capital gain is simply the profit on your investment when you sell your mutual fund units. It is the difference between the market value of your mutual fund units at the time of sale and the cost of such units. The gains come in from the appreciation in your fund’s NAV.(Net Asset Value)

Capital gains can be short term or long term, depending on how long you hold the fund units.

Holding period is the number of years between when you first bought a unit and sold it.

What is considered short-term and long-term holding varies between equity and debt / gold mutual funds.

In this article, we will look at how capital gains tax applies to equity mutual funds and debt funds.

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In the next one, we shall see how the taxes are calculated when you buy and sell at multiple points.

Income Tax on equity funds

Taxation rules on equity & equity-oriented funds are fairly simple. A holding period of more than 12 months (1 year) qualifies as long-term holding; less than that is short term.

Equity-oriented funds have no tax on long-term capital gains; i.e., if you sell your fund after 12 months from the date you bought it, you do not pay capital gains tax.

On short-term holding, the capital gains tax is a flat 15%, no matter which tax bracket you belong to.

Securities Transaction Tax - STT (at 0.001%) will apply on all redemptions of equity schemes. That is about one paisa for every Rs. 1.000 of redeemed money and hence ignorable.

All dividends from equity funds are exempt from tax, irrespective of when you receive it.

To qualify as an equity-oriented scheme as per tax rules, the fund should have at least 65% of its portfolio in domestic equity shares on an average.

By this definition, equity-oriented balanced funds are also tax-free after a one-year holding period, just like equity funds.

They are also taxed at 15% for short-term capital gains.

Similarly, arbitrage funds & equity savings funds are also treated as equity for tax purposes.

International funds that invest in the stocks of other markets such as the US or / Europe, will not be an equity fund as they do not hold domestic stocks to the extent of 65% (as required by tax laws).

Equity fund-of-fund schemes do not enjoy the tax benefits of equity funds because they do not hold stocks; they hold other funds.

Income Tax on debt funds..!

Debt funds, as a category, include liquid, ultra short-term, short-term, income accrual, dynamic bond, and gilt funds. It also includes all debt-oriented funds as MIPs (Monthly Income Plans) and other hybrid non-equity funds.

International funds and gold funds also follow the same taxation as debt funds.

For these funds, short-term is a holding period of less than 36 months. (3 years).

 Long-term holding is a period more than 36 months.

On short-term capital gains, you are taxed at your slab rate. (10%, 20%, 30%) That is, if you are in the 10% tax bracket, you pay 10% of your capital gains as tax. If you are in the 20% tax bracket, you pay 20% tax on your capital gain. If you are in the 30% tax bracket, you pay 30% tax on your capital gain.

On long-term capital gains, your tax is 20% of the gain with cost indexation benefits.

Indexation is the method by which your cost is adjusted for inflation.

What this does is to effectively reduce your absolute gain, as your cost goes up and thus reduces your taxable profit.

While equity funds do not suffer tax on dividend, debt funds do! You do not pay this tax – called dividend distribution tax (DDT).

 The AMC deducts it from your NAV and remits it directly. So you receive dividend net of DDT.

The DDT rate for individuals at present is 28.84% (including surcharge and cess).

Do note that as dividends are paid out from your NAV, your NAV falls post such dividend payout or / re- investment.

Hence, the capital gains, if any, when you sell your units under this option will seem lower.

But the fact remains that you paid tax on the dividend, which is nothing but part of your profit.

Hence, it is important for you to know whether it is suitable for you to opt for dividend option in debt, depending on your tax profile.

 We will do a separate article on how to optimally use the dividend and growth option.

Who pays the tax?

If you are a resident Indian, the fund house will not deduct any tax (TDS) when you sell your units.

You are required to show the income and pay taxes, if any, when you file your returns.

If you are a non-resident Indian, while the tax laws remain the same for capital gains, TDS will be deducted, at the applicable rates, when you sell your units.

Remember that any transaction that involves units going out of your holding qualifies as redemption.

So, if you are switching units from one scheme to another or / from the dividend to growth option (or / vice versa), or / making a systematic transfer plan (STP) or a systematic withdrawal plan (SWP), they are all redemptions.

Tax Reckoner 2015-2016  Src: Birla Sunlife MF

Snapshot of Tax rates specific to Mutual Funds Tax Implication on Dividend received by Unitholders. Individual/HUF Domestic Company NRI Dividend Equity Oriented Schemes Nil Nil Nil Debt Oriented Schemes Nil Nil Nil Tax on Distributed Income- SC changed from 10% to 12% So effective rate will be as follows Equity Oriented Schemes* NIL NIL NIL Money Market & Liquid Schemes 25% + 12% Surcharge + 3% Cess = 28.84% 30% + 12% Surcharge + 3% Cess = 34.608% 25% + 12% Surcharge + 3% Cess =28.84% Debt Schemes (Other than Infrastructure Debt Fund) 25% + 12% Surcharge + 3% Cess = 28.84% 30% + 12% Surcharge + 3% Cess =34.608% 25% + 12% Surcharge + 3% Cess = 28.84% Infra Debt fund 25% + 12% Surcharge + 3% Cess = 28.84% 30% + 12% Surcharge + 3% Cess = 34.608% 5% + 12% Surcharge + 3% Cess =5.768% * Securities transaction tax (STT) will be deducted on equity funds at the time of redemption/ switch to the other schemes/ sale of units. ** The Finance (No. 2) Bill, 2014 proposes that for the purpose of determining the tax payable, the amount of distributed income be increased to such amount as would, after reduction of tax from such increased amount, be equal to the income distributed by the Mutual Fund. The proposed change is effective from 1 October 2014. Capital Gains Taxation Individual/HUF $ Domestic Corporates @ NRI $ / # Equity Oriented Schemes - For the period April 1, 2014 onwards Long Term Capital Gains (units held for more than 12 months) o Short Term Capital Gains (units held for 12 months or less) Long Term Capital Gains NIL NIL NIL Short Term Capital Gains 15% 15% 15% Other Than Equity Oriented Schemes - For the period April 1, 2014 to July 10, 2014 Long Term Capital Gains (units held for more than 12 months) o Short Term Capital Gains (units held for 12 months or less) Long Term Capital Gains 20% + 10% whichever is low 20% + 10% whichever is low Listed - 20% or 10% whichever is low Unlisted - 10% Short Term Capital Gains 30%^ 30% 30%^ Other Than Equity Oriented Schemes - For the period July 11, 2014 onwards Long Term Capital Gains (units held for more than 36 months) o Short Term Capital Gains (units held for 36 months or less) Long Term Capital Gains 20%^ 20% Listed - 20% Unlisted - 10% Short Term Capital Gains 30%^ 30% 30%^ Tax Deducted at Source (Applicable only to NRI Investors) Short Term Capital Gains Long Term Capital Gains Equity Oriented Schemes 15% NIL Other than equity oriented schemes 30% 10% (for unlisted) & - 20% (for listed) $ Surcharge at 12% to be levied in case of individual/ HUF unit holders where their income exceeds Rs 1 crore. @ Surcharge at 7% to be levied for domestic corporate unit holders where the income exceeds Rs 1 crore but less than 10 crores and at 12%, where income exceeds Rs. 10 crores. # Short term/long term capital gain tax will be deducted at the time of redemption of units in case of NRI investors only. $ After providing indexation. # Without indexation ^ Assuming the investor falls into highest tax bracket. Education Cess at the rate 3% will continue to apply on tax plus surcharge Dividend Stripping: The loss due to sale of units in the schemes (where dividend is tax free) will not be available for set off to the extent of the tax free dividend declared; if units are:(A) bought within three months prior to the record date fixed for dividend declaration; and (B) sold within nine months after the record date fixed for dividend declaration. Bonus Stripping: The loss due to sale of original units in the schemes, where bonus units are issued, will not be available for set off; if original units are: (A) bought within three months prior to the record date fixed for allotment of bonus units; and (B) sold within nine months after the record date fixed for allotment of bonus units. However, the amount of loss so ignored shall be deemed to be the cost of purchase or acquisition of such unsold bonus units.

1. Income Tax Rates For Individual, Hindu Undivided Family, Association of Persons, Body of Individuals and Artificial juridical persons. Total Income Tax Rates (%) Upto Rs.2,50,000 (a)(b)(d) NIL Rs. 2,50,001 to Rs. 5,00,000 (d) 10% Rs. 5,00,001 to Rs.10,00,000(d) 20% Rs. 10,00,001 and above(c)(d) 30% (a) In the case of a resident individual of the age of 60 years or above but below 80 years, the basic exemption limit is Rs.3,00,000. (b) In the case of a resident individual of the age of 80 years or above, the basic exemption limit is Rs.5,00,000. (c) Surcharge @ 12% is applicable on income exceeding Rs. 1 Crore; marginal relief for such person is available. (d) Education cess is applicable @ 3% on income tax plus surcharge. 2. Securities Transaction Tax (STT) STT is levied on the value of taxable securities transactions as under: Transaction Rates Payable By Purchase/ Sale of equity shares 0.1% Purchaser/Seller Purchase of units of equity oriented mutual fund (delivery based) Nil Purchaser Sale of units of equity oriented mutual fund (delivery based) 0.001% Seller Sale of equity shares, units of equity oriented mutual fund (non-delivery based) 0.025% Seller Sale of an option in securities 0.017% Seller Sale of an option in securities, where option is exercised 0.125% Purchaser Sale of a future in securities 0.010% Seller Sale of unit of an equity oriented scheme to the Mutual Fund 0.001% Seller 3. Special rates for non-residents (1) The following incomes in the case of non-resident are taxed at special rates on gross basis: Transaction Rates Dividend (b) 20% Interested received on loans given in foriegn currency to Indian concern or Government of India 20% Income received in respect of units purchased in foreign currency of specifies Mutual Funds / UTI 20% Royalty or fees for technical services 10% Interest income from a notified Infrastructure Debt Fund 5% Interest on FCCB, FCEB / Dividend on GDRs(b) 10% (a) These rate will further increase by applicable surcharge and education cess. (b) Other than dividends on which DDT has been paid. (c) In case the non-resident has a Permanent Establisment(PE) in India and the royalty/fees for technical services paid is effectively connected with such PE , the same could be taxed at 40%(plus applicable surcharge and education cess) on net basis. (2) Tax on non-resident sportsmen or sports association on specified income @ 20% plus applicable surcharge and education cess. 4. Capital Gains Transaction Short Term Capital Gains(a) Long Term Capital Gains (a)(b) Sale transactions of equity shares / units of an equity oriented fund which attract STT 15% Nil Sale transaction of other than units mentioned above: Individuals (resident and non-residents) Progressive slab rates 20% / 10% Partnership (resident and non-resident) 30% Resident Companies 30% Overseas financial organisations specified in section 115AB 40% (corporate) 30% (non-corporate) 10% FIIs 30% 10% Other Foreign companies 40% 20% / 10% Local authorities 30% 20% / 10% Co-operative society Progressive slab (a) These rates will further increase by surcharge, as applicable & education cess. (b) Indexation benefit, as applicable. 5.Personal Tax Scenarios (Amount in Rupees) Individual Income Level (Rs.) 500,000 5,000,000 11,000,000 Tax in FY 2014-15 25,750 1,364,750 3,540,625 Tax in FY 2015-16 25,750 1,364,750 3,605,000 Effective Tax Savings NA NA NA Effective Tax Savings NA NA NA Additional Tax Burden NA NA 64,375 Additional Tax Burden NA NA 1.82% Resident Senior Citizen (age of 60 years but below 80 years) Income Level (Rs.) 500,000 5,000,000 11,000,000 Tax in FY 2014-15 20,600 1,359,600 3,534,960 Tax in FY 2015-16 20,600 1,359,600 3,599,232 Effective Tax Savings NA NA NA Effective Tax Savings NA NA NA Additional Tax Burden NA NA 64,272 Additional Tax Burden NA NA 1.82% Resident very senior citizen Income Level at the age of 80 years and above Income Level 500,000 5,000,000 11,000,000 Tax in FY 2014-15 - 1,339,000 3,512,300 Tax in FY 2015-16 - 1,339,000 3,576,160 Effective Tax Savings NA NA NA Effective Tax Savings NA NA NA Additional Tax Burden NA NA 63,860 Additional Tax Burden NA NA 1.82% Marginal relief as applicable would be available The tax rates mentioned above are those provided in the Income tax Act, 1961 and amended as per Finance Act, 2015, applicable for the financial year 2015-16 relevant to assessment year 2016-17. In the event of any change, we do not assume any responsibility to update the tax rates consequent to such changes. The tax rates mentioned above may not be exhaustive rates applicable to all types of assesses /taxpayers. The tax rates mentioned above are only intended to provide general information and are neither designed nor intended to be a substitute for professional tax advice. Applicability of the tax rates would depend upon nature of the transaction, the tax consequences thereon and the tax laws in force at the relevant point in time. Therefore, users are advised that before making any decision or taking any action that might affect their finances or business, they should take professional advice. A non-resident tax payer has an option to be governed by the provisions of the Income tax Act, 1961 or the provisions of the relevant DTAA, whichever is more beneficial. As per the provisions of the Income tax Act, 1961, submission of tax residency certificate ("TRC") along with Form No. 10F will be necessary for granting DTAA benefits to non-residents. A taxpayer claiming DTAA benefit shall furnish a TRC of his residence obtained by him from the Government of that country or specified territory. Further, in addition to the TRC, the non-resident may be required to provide such other documents and information subsequently, as may be prescribed by the Indian Tax Authorities.

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Disclaimer :The information set out above is included for general information purposes only and does not constitute legal or tax advice. In view of the individual nature of the tax consequences, each investor is advised to consult his or her own tax consultant with respect to specific tax implications arising out of their participation in the Scheme. Income Tax benefits to the mutual fund & to the unit holder is in accordance with the prevailing tax laws as certified by the mutual funds tax consultant. Any action taken by you on the basis of the information contained herein is your responsibility alone. Birla Sun Life Mutual Fund will not be liable in any manner for the consequences of such action taken by you. The information contained herein is not intended as an offer or solicitation for the purchase and sales of any schemes of Birla Sun Life Mutual Fund.

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