Wednesday, April 22, 2009

INCOME TAX IMPLICATIONS ON MUTUAL FUND GAINS

We all invest in mutual funds and get the returns either in the form of dividends or get capital appreciation benefits under growth option. But do we know how is this income taxed in India? What are the tax implications on the income arising out of mutual fund investments? Will try and answer this today.We will look at how income arising from mutual funds are taxed for an individual investor. The income from mutual funds can arise out of dividend received from the fund or from the capital gains (short term or long term).
Let us understand how is the income arising out of dividend and capital gains taxed as per Income Tax Act in India.
1. DIVIDEND
a.On units of equity oriented funds (funds having more than 65% investments in Indian equity instruments)
Income in the form of dividend is tax free in the hands of the investor. Moreover such a fund house is exempt from paying Dividend Distribution Tax also.
b.On units of funds other than equity oriented funds
Income in the form of dividends is tax free. However, the fund house needs to pay Dividend Distribution Tax (DDT) at the time of distributing the dividend.The rate of dividend distribution tax depends on who is the recipient of the dividend and is calculated as under- Individual and HUF - 14.025%- Others like corporate - 22.44%
2. CAPITAL GAINS
Capital gains is classified into 2 categories i.e. Short term and long term capital gains. Short term capital gains arises out of sale of units held for less than 12 months and long term capital gains arises out of sale of units held for more than 12 months.
a Short Term capital Gains
-On units of equity oriented funds (funds having more than 65% investments in Indian equity instruments)
The income arising out of short term capital gains in mutual funds is to be taxed at the rate of 10% plus applicable surcharges.
-On units of funds other than equity oriented funds
Short term capital gains is added back to your income and then your total income is taxed as per the IT slab i.e. 10% or 20% or 30% for the ones falling in the highest bracket.
b. Long Term capital Gains
-On units of equity oriented funds (funds having more than 65% investments in Indian equity instruments)
Tax free
--On units of funds other than equity oriented funds
There are 2 methods for this.
1. The investor can calculate capital gains taking the benefit of indexation and pay tax at the rate of 20% plus surcharge.or
2. The investor can calculate the capital gains without the benefit of indexation and pay tax at 10%.
What should you do ? I would argue that for wealth building sake one should go in for growth option which will result in long term capital gains for you. This will result in long term wealth building due to the power of compounding in your fund and also is tax efficient as is evident above. Dividend option works fro people who are more concerned about getting some liquidity back at regular intervals.

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