Mutual Fund is a trust that pools together the resources of investors to make into investments in the capital market thereby making the investor to be a part owner of the assets of the mutual fund. The fund is managed by a professional money manager who invests the money collected from different investors in various stocks, bonds or other securities according to specific investment objectives as established by the fund. If the value of the mutual fund investments goes up, the return on them increases and vice versa. The net income earned on the funds, along with capital appreciation of the investment, is shared amongst the unit holders in proportion to the units owned by them. Mutual Fund is therefore an indirect vehicle for the investor investing in capital markets. In return for administering the fund and managing its investment portfolio, the fund manager charges fees based on the value of the fund’s assets.

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Income Tax Perspective

  • Investment Benefits

Section 80C (2) (xiii) of the Income Tax Act, 1961, specifies deduction from Gross Total Income of a person in respect of subscription to any units of any Mutual Fund referred to in Clause (23D) of Section 10 or from Administrator or the specified company under any plan formulated in accordance with such scheme as the Central Government may, by notification in the Official Gazette, specify in this behalf. Maximum Limit of Deduction is Rs. 150000.

  Mutual Funds referred under Section 10(23D) of the IT Act, 1961 are:

  • Mutual Fund registered under Securities and Exchange Board of India Act, 1992.
  • Such other Mutual Funds set up by a public sector bank or a public financial institution or authorized by the RBI and subject to such conditions as may be notified by Central Government in the Official Gazette.

Pursuant to this, the Central Government has notified Equity Linked Saving Scheme 2005 to be eligible for the deduction under section 80C.

Section 80C (2) (xx) specifies deduction in respect of subscription to any units of any mutual fund referred to in clause (23D) of section 10 and approved by the Board on an application made by mutual fund in the prescribed form. It is required that such funds must invest only in the eligible issue of capital of an Indian Public Company/ a PFI carrying any business referred to in Section 80-IA(4) (related to Infrastructure, Telecommunication, Power sector etc.)

  • Taxability of Income from units of Mutual Fund

The Income received from Mutual Fund is in the form of dividend. Following are the key points regarding taxability of such dividend income from subscription of units of Mutual Fund:

  • Any income/ dividend received from units of Mutual Fund specified under clause (23D) of Section 10 is exempt from Income Tax under section 10(35). This is irrespective of whether it is an equity fund scheme or debt fund scheme.
  • Earlier the income received by way of dividends from Mutual Fund other than those mentioned under clause (23D) of section 10 is exempt & subject to DDT payment by the Mutual fund. However, w.e.f 01.04.2020 the dividend shall be taxed in the hands of the assesses at the normal slab rate applicable to the them. If such income exceeds Rs. 5000 in a year the mutual fund shall also deduct tax @10% from such income under the section 194K, credit of which can be availed while filing ITR.

 

  • There are generally two options available for investors in respect of dividend payment:
    • Dividend Reinvestment Plan: In this plan, dividend is reinvested in the Mutual Fund and thereby increases the investment. This plan is suitable for investors of lower or medium income brackets, if investment in funds is eligible for deduction under Section 80C. For investors in higher tax brackets, Dividend Reinvestment plan may become a source of growing investment base but deduction benefit of Section 80C may be negligible if the assessee has already availed full deduction through other eligible investments as per Sec 80C of the Income Tax Act,1961.
    • Dividend Payout Plan: This is a normal option where funds are invested in mutual fund and then investor receives dividend. This option is suitable for investors in high income brackets.

 

  • Capital Gain on Sale of units of Mutual Fund

The following table shows the taxability of sale of units of mutual funds in different situations:

 Type of Fund  Short-term Capital Gain  Long-term Capital Gain
 Equity-oriented Fund

 

1.   Where STT is paid

 

2.   Where STT is not paid

  

Taxable @15% under section 111A

 

 

Taxable at normal slab rate (if the units are sold before one year)

Exempt but up to Rs. 1 lakhs only. After Rs. 1 Lakhs, capital gains are taxed @ 10 % without indexation under section 112A .

 

Taxable @20% with indexation under  Section 112
 Debt-oriented Fund  Taxable at normal slab rate(if the units are sold before three years)

Taxable @20% with indexation under  Section 112

Equity oriented Fund is a fund where more than 65 % of proceeds of fund are invested in Equity shares of Domestic company.
As per section 2(42A) of the IT Act, 1961, a capital asset is considered to be short- term capital asset when held by assessee for not more than 36 months. However, a unit of an listed equity oriented fund is considered to be short term capital asset when held for not more than 12 months.

The LTCG on sale of unlisted securities for non-resident (other than company) or a foreign company may also be calculated @10% without indexation benefit.