The basis of any investment is benefitting the most you possibly can out of the potential gain. It is the primary preference and the fundamental wish, to gain maximum returns while eradicating any unwanted risks. Learning about the taxes that affect your annual income or profitable returns can help you maximize the potential gain.

The taxation that applies to mutual funds come as a cause of investing in the mutual funds. By getting ahead of the task and acquiring knowledge about the potential taxes, you can help eliminate the unwanted ones and get better at reducing the risk factor on your returns.  Some of the facts related to mutual funds are provided below to help better understand the concepts behind the popular mutual funds.

The holding period of mutual funds

The holding period on mutual funds varies from scheme to scheme. For example, 12 months are considered as a long term for equity and balanced mutual funds. Hence, the LTCG tax applies to it. For debt funds, the long period is around 36 months. Similarly, anything less than 36 months for debt funds is considered short term. Hence, STCGs are applied.

How are mutual funds taxed?

Let’s go through taxation of some of the well-known mutual funds such as tax saving equity funds, non-tax saving equity funds, debt funds, ELSS and more. 

• Tax Saving Equity Funds:

ELSS (Equity linked saving scheme) is one of the most popular tax saving schemes as per Section 80C. It has a lock-in long term period of about 3 years. You can withdraw your investment only after this duration. The long term capital gain(LTCG) on it can be upto Rs. 100,000 without any taxes. Any amount above that is taxed at 10%. Additionally, this has a benefit on indexation, so it is a win-win mutual funds scheme for you.

• Pure Equity Funds:

In case of Equity mutual funds, LTCG is 10% for gains exceeding Rs. 1 lakh (if STT is Paid) and Short Term Capital Gain(STCG) is 15%.

• Debt Funds

In debt mutual fund, LTCG taxed at 20% in after indexation and STCG is as per the tax slab of individual or marginal tax. LTCG in case of indexation is calculated as:

Sale Price-Indexed cost of acquisition=LTCG

• Balanced Funds

These are equity-centric hybrid funds with an investment of about 65% of the funds in equities. This way it gets taxation similar to equity funds.

Tax efficient funds:

The foremost thing to aim for is fetching for investments and acquiring ownership of such accounts that do not yield taxes. There are accounts such as a regular individual account or a joint one which is taxable accounts and taxes are something that you need to minimize when it comes to investments. Hence, it is advisable to invest in mutual funds that generate little or no tax at all.

Tax loss harvesting:

There are many people who face some common misconception of taxation in the mutual funds. The recurring mistake that is known is that when investors deal with mutual funds, they pay the taxes on capital gains which can be reduced to a great extent or be eradicated with the help of offsetting them into capital losses. The resulting situation comes as a tax-free option for the investors.

Mutual funds dividends:

Dividends are bonuses that are passed on to the stock shareholders by certain companies. Mutual funds, therefore, assist the transfer of dividends from the companies dealing with the investment of stocks and pass these dividends on to the mutual funds’ shareholders. People in this are often preferred that the dividends be reinvested into the mutual funds which reduce the chances of increased taxes.

Mutual Fund Capital Gains Distributions:

When mutual funds managers buy or sell the shares of stocks inside the mutual funds itself, they usually purchase the ones that have gathered considerable value over time. when the valued purchases become even more valued after the purchase, the trades exhibit capital gains. These capital gains can be acquired over any period of time of the annual mutual funds and are passed on to the investor.

Tax cost ratio:

The name refers to the calculation of how much impact the tax incurs on the net returns of the investment. The tax ratio of mutual funds can also be determined by simple math. Investors who are devoted to mutual funds and the respective investments can analyze their tax ratios and do better at obtaining the potential returns from their investments, thereby reducing the risk affecting their returns.