What is the Mutual fund taxation for FY 2020-21: Know Here

What is the Mutual fund taxation for FY 2020-21: Know Here

Some important tax changes were announced in the Union Budget of 2020. Taxation is an essential consideration in financial planning from various tax savings options to tax results of your investments. Investors should note that several important changes were published in the Budget which may have an impact on your income tax.

In this blog post, we will consider only mutual fund taxation for FY 2020-21, including the impact of the reforms announced in the 2020 Budget. You should discuss with your tax consultant or chartered accountant to know about the other tax reforms, including the new tax regime.

Types of mutual funds for tax purposes

We have discussed various types of mutual funds in our blog, but for purposes of taxation, there are two kinds of funds:-

  • Equity Funds: From a tax perspective, a fund in which at least 65% of the portfolio is allotted to domestic (Indian) equities is an equity fund. Please note that as far as mutual fund taxation is affected, derivatives whose underlying assets are stocks (or stock indices) are also supposed to be equity. Apart from funds that are categorized as equity funds as per SEBI’s analysis, certain types of hybrid funds where average gross equity allocation is larger than 65%, like aggressive hybrid funds, arbitrage funds, equity savings funds, etc are also used as equity funds from a tax perspective. ETFs and index funds are also required as equity funds since the underlying asset class (at least 65%) is Indian equities. If you are uncertain about the tax treatment of a mutual fund scheme in your portfolio, you should discuss your financial advisor.
  • Non-Equity Funds: Non-Equity funds from a tax viewpoint are mutual fund schemes that have less than 65% allocation to equity in their collection. Non-equity funds include schemes that are classified as debt funds as per SEBI’s comments and certain types of hybrid funds where equity allocation is less than 65%, like conservative hybrid stores. Investors should note that mutual fund schemes that invest primarily in global equities are taxed as non-equity funds, even though the underlying asset category is equity. Investors also note that Fund of funds, whether the underlying funds are equity funds or not, are handled as non-equity funds. Gold ETFs, Gold fund of funds are also employed as non-equity funds. Again, if you are uncertain about the tax treatment of a mutual fund scheme in your portfolio, you should advise your financial advisor.

Incidence of taxation in mutual funds

New mutual fund investors should remember that the incidence of taxation in mutual funds arise only for the following outcomes:-

  • Capital Gains: Capital gain is the attraction in the value (redemption value – purchase value) of the units of a mutual fund that are redeemed. Investors should remember that capital gains are taxed only at the time of redemption or sale. In other words, capital gains tax is levied only on realized profits. If your mutual fund units have appreciated and you are still keeping them, then there is no taxation on the unrealized gains.
  • Dividends: Dividends are gains made by a mutual fund scheme that is paid to unit-holders at periods determined by the Asset Management Companies. Dividends may be adjusted yearly, quarterly, monthly, etc. All profits are taxed. If a project does not pay dividends and you do not make any improvement, then there will be no tax on the scheme. An important change has been performed in dividend taxation in the 2020 Union Budget, which we will address later in this post.

Capital gains taxation

  • For equity funds: If you sell parts of equity funds before completion of 1 year from the date of investment, then it is handled as short-term capital gains from a tax standpoint. Short term capital additions in equity funds are taxed at the rate of 15% plus 4% cess and applicable surcharge (if any). If you exchange units of equity funds after completion of 1 year from the date of investment, then it is handled as long term capital gain. Long term capital increases of up to Rs 1 Lakh are tax exempt in a financial year. Long Term Capital gains in excess of Rs 1 Lakh are taxed at 10% plus cess and appropriate surcharge (if any).
  • For non-equity funds: If you exchange units of non-equity funds before completion of 3 years from the date of investment, then it is treated as short term capital profits from a tax stand point. Short term capital gains in non-equity funds are attached to the income of the investor in his / her Income Tax Returns and taxed as per the applicable tax rate (including cess and applicable surcharge) of the investor. If you trade units of non-equity funds after completion of 3 years from the date of investment, then it is handled as long term capital gains from a tax standpoint. Long term capital gains of non-equity funds are charged at 20% with indexation. To determine capital gains with indexation, you should arrange your purchase cost by multiplying the purchase cost with the ratio of the cost of inflation index of the year of sale and payment of inflation index of the year of purchase, and then decrease the indexed purchase cost from sales value.

Dividends taxation

There have been some changes to the taxation of dividends paid by mutual funds over the past two years. We will not go into the account of tax changes in mutual fund dividends in this post but returns to say that before the current financial year dividends were tax-free in the administration of the investors. However, before this financial year, the AMC had to adjust dividend administration tax (DDT) before paying distributions to investors. The DDT was obviously deducted from the profits and what investors got was net of DDT.

One of the most significant tax changes in the 2020 Union Budget was the abolition of the Dividend Distribution Tax, which authorities saw as a regressive tax. Going forward, AMCs will not diminish DDT from mutual fund dividends. So dividends in the hands of the investors are likely to increase in absence of DDT. However, earnings now will be taxed at the hands of the investors. Dividends paid by mutual funds (whether equity funds or non-equity stocks) will now be added to the interest of the investor in his / her Income Tax Returns and taxed as per the applicable tax rate (including cess and applicable surtax) of the investor.

What are the implications of the dividend tax change?

We had considered the implications of dividends tax change in our post, Implications of 2020 Budget: Growth versus Dividend Option of mutual funds (we urge investors to go into this post if you have not already read it before). However, for the interest of new investors on our website, we will recap in brief, the implications of profits tax change for equity and non-equity funds.

Before the current fiscal, the DDT for equity-oriented stocks was 11.65%. So if your income tax slab rate is less than 10%, then these quarters will be beneficial for you. For income in higher tax brackets, this transition will result in more taxes. The DDT for non-equity funds (debt reserves and debt-oriented hybrid reserves) prior to this fiscal was 29.12%. The change in dividend taxation will be beneficial for all investors whose interest tax slab is less than 30%. However, for investors in the 30% tax support, this change will occur in more tax reduction.

Review of capital gains and dividends taxation (FY 2020-21)

Tax Savings u/s 80C

Investors can maintain deductions of up to Rs 1.5 lakhs from their gross taxable incomes by investing in available schemes under Section 80C of the Income Tax Act of 1961. Mutual fund Equity Connected Savings Schemes are eligible for Section 80C tax benefits. Investments of up to Rs 1.5 lakhs in Equity Linked Savings Schemes (ELSS) will change for deduction from your taxable income for income tax calculation.

However, as per Union Budget 2020, 80C tax compensation will be available only for investors who opt to settle in the old income tax regime. If you opt for the new tax administration, you will not be eligible to claim deductions under Section 80C. You should discuss with your tax consultant or chartered accountant to understand more about the old and new tax regimes to plan your taxes respectively.

Conclusion

In this post, we have examined the effect of taxes on your mutual fund investments. When filing Income Tax Returns (ITR), you should thoroughly go through all the mutual fund redemptions made during the financial year and determine the capital gains. You also need to publish all the dividends received by you in your Income Tax Returns. You can get your capital gains and dividends reports online from mutual fund registrars (RTAs). You can likewise ask your financial advisor to provide you with one. You should name your capital gains and dividends in your income tax returns and pay taxes equally. If you are in any doubt you should discuss this with your tax consultant.