Do you know revised mutual fund taxation rules?

Mutual funds have become a household name. There would be very few people from metro cities who would have not invested in mutual funds so far.

Before 2023, the taxation on mutual funds for an Individual was much simpler. One needed to decide:

• If equity mutual funds (65% or more invested in stocks) - 10% if it is held for more than a year, and 15% if it is held for less than a year.

• If debt or other mutual funds (35% or less invested in stocks) - 20% (after indexation) if it is held for more than 36 months and as per slab rate if it is held for less than 36 months.

A surcharge of 10% or 15% on the tax rate mentioned above was applicable if the total income of a person was more than Rs. 50 lakhs or Rs. 1 crore respectively. 4% cess was applicable irrespective of any category and any slab.

From 2023 onwards, in regards to the Mutual Fund taxation, you first have to be able to classify your fund either as,

(a) Fund investing less than 35% in Equity - This fund will get Debt Taxation

(b) Fund investing between 35% - 64% in Equity - This fund will get Debt + Indexation Taxation

(c) Fund investing 65% & more in Equity - This fund will get Equity Taxation

From 2023 and onwards, What’s Equity Taxation?

- Short Term Capital Gains Tax (STCG) - 15% tax on capital gains if your holding period is less than 1 year

- Long Term Capital Gains Tax (LTCG) - 10% tax on capital gains if your holding period is more than 1 year

i.e. - If your 100 invested becomes 150, 50 is the capital gains. You pay 10% 50 = 5 as tax if your holding period is more than a year or 15% 50 = 7.5 as tax if your holding period is less than a year

From 2023 and onwards, What’s Debt Taxation?

You pay slab rate tax on your investment irrespective of the period of holding. So if Rs. 100 invested becomes Rs. 150, you pay 5%, 10%, 15%, 20%, 30% whatever slab you are in income tax as a tax on the Rs. 50 of capital gains in this example.

i.e. - Irrespective of your holding period, if you are in the 30% tax slab, you pay 30% on the Rs. 50 = Rs. 15 as a tax on the capital gains

From 2023 and onwards, What’s Debt + Indexation Taxation?

- STCG - Slab rate tax on capital gains if your holding period is less than 3 years

- LTCG - 20% tax with indexation on capital gains if your holding period is more than 3 year

i.e.

- STCG is straightforward, you pay slab rates for less than 3 years of holding

- Here’s how LTCG works. If in 4 years of holding, the fund generates 9% & inflation for the last 4 years was 6% then you pay 20% tax on the difference between 9% - 6% = 3%. So the tax you pay is 20% * 3% = 0.6% & the net return is 9 - 0.6 = 8.4%

Advantage of opting for Hybrid Funds instead of Fixed Deposits: Debt + Indexation

Let’s say I invest today in December 2023 in a hybrid fund which has Debt + Indexation advantage & withdraws in March 2027, theoretically, I have invested for ~3 years but I will receive 4 years of indexation advantage as indexation is as per financial year & I will get the benefit of 1 full year by just investing for 3 months in this financial year & hence my net tax will be even lower.

If Rs. 2 crores are invested in Fixed Deposits, and the interest rate is 7.5% p.a., for a person in a 30% tax bracket, one needs to pay Rs. 4.5 lakhs on the interest of Rs. 15 lakhs. Hence the net interest available to spend is Rs. 10.5 lakhs only which is 5.25% p.a. post tax. In Hybrid Funds with the Debt + Indexation option, If you take out Rs. 15 lakhs as interest, you pay a tax of Rs. 31,000 for the first three years, and after that, almost no tax.

How are dividends taxed?

- Dividend plans in Mutual Funds are called IDCW (Income Distribution cum Capital Withdrawal)

- Dividends are taxed at slab rates. So you pay 30% on the dividends received if you are in the 30% tax slab.

- As a long-term investor, it’s a big mistake to opt for IDCW over the growth option in Equity, which is taxed at 10% in the long term. Also in Debt, use the SWP method to withdraw over IDCW to save taxes.

What are the risks in Hybrid Funds?

Since Hybrid Funds with Debt + Indexation option have equity, it is not completely fixed. There would be periodic ups and downs as there would be 20-30% of equity in the portfolio. However, there are certain data points which denote that the Indian equity market is likely to give reasonable returns over the next 8-10 years.

Rising Trend in Indian Corporate Profits!

Profit as a % of GDP is high despite Low Leverage

There is a rise in India’s corporate profitability but with low leverage.

India’s corporates are doing well with low leverage as compared to previous decades. This is the reason why they can withstand knee-jerk reactions of political uncertainty and thrive in good times.

I hope this guide is useful in making informed decisions on mutual funds. For our clients, we shall be providing the capital gain reports after March 2024 that would have this classification as mentioned above.

Warm regards,

Tejas Lakhani
Chartered Accountant
Fincare Services