What tax benefits are available to those who invest in mutual funds? Please mention the tax benefits on equity-oriented and debt-oriented funds separately.
Dividends declared by debt-oriented mutual funds (i.e. mutual funds with less than 65% of assets in equities), are tax-free in the hands of the investor. However, a dividend distribution tax of 14.03% (including surcharge) is to be paid by the mutual fund on the dividends declared. Long-term debt funds, government securities funds (gsec/gilt funds), monthtly income plans (MIPs) are examples of debt-oriented funds.
Dividends declared by equity-oriented funds (i.e. mutual funds with more than 65% of assets in equities) are tax-free in the hands of investor. There is also no dividend distribution tax applicable on these funds. Diversified equity funds, sector funds, balanced funds (with more than 65% of net assets in equities) are examples of equity-oriented funds.
Amount invested in tax-saving funds (ELSS) would be eligible for deduction under Section 80C, however the aggregate amount deductible under the said section cannot exceed Rs 100,000.
How are equity-oriented funds defined?
A mutual fund must have at least 65% of its net assets in equities/stocks to qualify as an equity-oriented mutual fund
Do equity/balanced funds have to maintain a daily, minimum 65% equity allocation?
Not really, the equity allocation is calculated based on the weekly average net assets in equities. If this average is below 65%, the fund stands to forfeit its equity-oriented status.
Do balanced funds qualify as equity-oriented funds?
If balanced funds maintain a minimum (average) 65% equity allocation, they do qualify as equity-oriented funds.
Is a capital gain on sale/transfer of units of mutual fund liable to tax? If yes, at what rate?
Section 2(42A): Under Section 2(42A) of the Act, a unit of a mutual fund is treated as short-term capital asset if the same is held for less than 12 months. The units held for more than twelve months are treated as long-term capital asset.
Section 10(38): Under Section 10(38) of the Act, long term capital gains arising from transfer of a unit of mutual fund is exempt from tax if the said transaction is undertaken after October 1, 2004 and the securities transaction tax is paid to the appropriate authority. This makes long-term capital gains on equity-oriented funds exempt from tax from assessment year 2005-06.
Short term capital gains on equity-oriented funds is chargeable to tax @10% (plus education cess, applicable surcharge). However, such securities transaction tax will be allowed as rebate under Section 88E of the Act, if the transaction constitutes business income.
Long-term capital gains on debt-oriented funds are subject to tax @20% of capital gain after allowing indexation benefit or at 10% flat without indexation benefit, whichever is less.
Short-term capital gains on debt-oriented funds are subject to tax at the tax bracket applicable (marginal tax rate) to the investor.
Section 112: Under Section 112 of the Act, capital gains, not covered by the exemption under Section 10(38), chargeable on transfer of long-term capital assets are subject to following rates of tax:
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Resident Individual & HUF - 20% plus surcharge, education cess.
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Partnership Firms & Indian Companies - 20% plus surcharge.
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Foreign Companies - 20% (no surcharge)
Capital gains will be computed after taking into account the cost of acquisition as adjusted by Cost Inflation Index, notified by the Central Government.
"Units" are included in the proviso to the sub-section (1) to Section 112 of the Act and hence, unit holders can opt for being taxed at 10% (plus applicable surcharge, education cess) without the cost inflation index benefit or 20% (plus applicable surcharge) with the cost inflation index benefit, whichever is beneficial.
Under Section 115AB of the Income Tax Act, 1961, long term capital gains in respect of units, purchased in foreign currency by an overseas financial, held for a period of more than 12 months, will be chargeable at the rate of 10%. Such gains will be calculated without indexation of cost of acquisition. No surcharge is applicable for taxes under section 115AB, in respect of corporate bodies.
Is it possible to offset the capital loss on a mutual fund investment after a dividend declaration?
This is a practice that is popularly referred to as 'dividend stripping'. The capital loss from a dividend declaration can be offset if you have remained invested in the mutual fund 3 months before and 9 months after the dividend declaration. If you haven't adhered to this guideline then you cannot offset the capital loss arising from a dividend declaration.
What is the tax implication of a bonus/rights issue on mutual fund units?
Under Section 55(2) (AA), bonus on mutual fund units has a zero (nil) cost of acquisition. The holding period is calculated from the date of allotment of mutual fund units. The net sales proceeds are treated as the capital gain. The period of holding of such issue is reckoned from the date of the allotment of such issue.
The cost of acquisition of the rights issue on mutual fund units is the amount actually paid for acquiring such right, according to Section 55(2) (AA) (iii). The holding period is reckoned from the date of allotment.
Where there is a transfer of these rights, the cost of acquisition of such rights is to be taken as 'Nil' according to Section 55(2) (AA) (ii). Sale price of such transferred rights will be taken as capital gain.
The period of holding in the hands of the transferor is computed from the date of offer, made by the company to the date of renouncement.
What are the tax benefits for the foreign investors?
Section 115E: Under Section 115E of the Act, capital gains, chargeable on transfer of long-term capital assets of an Non-Resident Indians (NRIs) are subject to following rates of tax:
Investment income: 20%
Long term capital gains: 10%
Subject to surcharge and education cess.
Section 10(23D): Under provisions of section 10(23D) of the Act, any income received by the Mutual Fund is exempt from tax.
Section 115R: Under Section 115R, the Income distributed to a unit holder of a Mutual Fund shall be charged to following rates of tax to be payable by the Mutual Fund.
Amounts distributed to individual or HUF: 12.5% + SC, EC
Amounts distributed to others: 20.0% + SC, EC
However, the above distribution tax will be exempted for an open-ended Equity-Oriented Funds (funds, investing more than 50% in equity or equity related instruments).
Is wealth tax applicable to mutual fund investments?
No. Units, held under the Scheme of the Fund, are not treated as assets within the meaning of Section 2(EA) of the Wealth Tax Act, 1957 and are, therefore, not liable to Wealth-Tax.
Is gift tax applicable to mutual funds investments?
No. Units of the mutual fund may be given as a gift and no gift tax will be payable, either by the donor or the donee.
How can I avoid payment of capital gains on mutual fund investments?
The capital gain, which is not exempt from tax as explained above, can be invested in the specified asset, mentioned below, within 6 months of the sale.
Specified asset means any bond redeemable after 3 years:
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Issued on or after April 1, 2000 by NABARD (National Bank for Agriculture and Rural Development or NHA (National Highways Authority of India
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Issued on or after April 1, 2001 by the Rural Electrification Corporation Ltd.
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Issued on or after April 1, 2002 by the National Housing Bank or by the Small Industries Development Bank of India.
Such capital gains can also be invested in any residential house property in accordance with Section 54F of the Act and one can claim exemption from capital gains.
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