Taxation on equity mutual funds: A complete guide

Equity mutual funds offer investors an excellent way to participate in the growth of the stock market and build long term wealth. However, it is important to understand how capital gains and dividends from such funds are taxed. Proper tax planning can help optimise the return potential from your equity mutual fund investments.

Read on to learn more about equity fund taxation and tips to save tax on equity fund under section 80C of the Income Tax Act, 1961.

• Table of contents

1. Tax benefits of equity mutual funds
2. Taxation of capital gains from equity funds
3. 80C tax saving tips for equity funds
4. Tax planning for equity funds through SIP
5. FAQ

Tax benefits of equity mutual funds

One of the major tax benefits of investing in equity mutual funds is the deduction available under Section 80C of the Income Tax Act, 1961. For example, Equity Linked Savings Schemes or ELSS funds qualify for tax deductions up to Rs. 1.5 lakh under Section 80C of the Income Tax Act, 1961. ELSS are open-ended equity diversified schemes that invest a minimum of 80% of their total assets in equities. They offer the dual advantage of tax savings as well as participation in equity markets. However, one thing to note is that the overall deduction limit under Section 80C is Rs. 1.5 lakh, including investments made in instruments like PPF, EPF, NSC etc.

Taxation of capital gains from equity funds

Capital gains arising from the sale of mutual fund units are taxed based on whether they are classified as short-term or long-term capital gains.

Short term capital gains (STCG) - If units are sold before completing 12 months from the date of allotment, the gains are termed as short term and taxed at 15% plus applicable surcharge and cess.

Long term capital gains (LTCG) - Units sold after 12 months from the date of allotment attract long term capital gains tax. LTCG up to Rs. 1 lakh per financial year is exempt from tax. Above Rs. 1 lakh, it is taxed at 10% plus applicable surcharge and cess.

80C tax saving tips for equity funds

• Invest in ELSS funds as they qualify for tax deduction up to Rs. 1.5 lakh under section 80C of the Income Tax Act, 1961. Since the mandatory lock-in period is 3 years, all gains from ELSS funds get LTCG benefits.
• Choose growth option to get compounding benefit over longer period. Capital gains attract more beneficial tax treatment compared to Income Distribution cum Capital Withdrawal (IDCW) income.
• Invest lumpsum amount at the start of the financial year for maximum deduction. Balance can be invested via SIP throughout the year under the 80C limit.

Tax planning for equity funds through SIP

Systematic Investment Plans or SIPs are ideal for tax efficient investing in equity mutual funds. Each SIP installment is treated as a separate investment with its own cost of acquisition and indexation benefits. Only the gains arising from the first SIP installment held for more than 12 months will qualify for tax exemption up to Rs. 1 lakh under long term capital gains. Profits from other installments sold before completing one year are subject to short term capital gains tax of 15%.

Conclusion

Systematic Investment Plans or SIPs are ideal for tax efficient investing in equity mutual funds. Each SIP installment is treated as a separate investment with its own cost of acquisition and indexation benefits. Only the gains arising from the first SIP installment held for more than 12 months will qualify for tax exemption up to Rs. 1 lakh under long term capital gains. Profits from other installments sold before completing one year are subject to short term capital gains tax of 15%.

FAQs:

Can I claim tax deduction for the entire Rs. 1.5 lakh limit under Section 80C of Income Tax Act, 1961 in equity funds alone?
No, the Rs. 1.5 lakh deduction under Section 80C of Income Tax Act, 1961 is the overall limit that can be claimed by an individual for investing in instruments like PPF, EPF, ELSS funds, NSC etc. combined. Only up to Rs. 1.5 lakh worth of investments made in these qualified instruments together will get tax benefits under Section 80C.

What is an ideal way to invest in ELSS funds to optimize tax savings on equity mutual fund in 80C?
It is ideal to invest the maximum limit of Rs. 1.5 lakh in ELSS funds at the beginning of the financial year itself to get a full tax deduction. Any additional amounts can be invested through SIPs in ELSS or other equity funds over the course of the year. This ensures optimal utilisation of the 80C tax saving limit.

Can I claim deductions for investments made in my spouse's name under Section 80C of the Income tax Act, 1961?
No, tax deductions under Section 80C can only be claimed for investments made individually by self or HUF. Any amount invested by a spouse cannot be claimed as a deduction in the taxpayer's own returns.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.