How to file ITR with mutual fund investments

Most of us know the importance of selecting a suitable mutual fund, so that investment outcomes can potentially be aligned with our goals. However, not many realise that filing accurate Income Tax Returns (ITR) with mutual fund investments is equally important, so that your tax outflow does not eat significantly into your net return potential.

Since mutual funds generate potential income and returns, every investor must know how they are taxed and how they should be disclosed it in the ITR.

In this article, we have simplified the process of filing ITR for mutual fund to help you with the approaching tax season.

• Table of contents

• What are the types of income from mutual funds?
• How are mutual funds taxed?
• Tax benefits in mutual funds
• What are the rules to disclose mutual fund income in ITR?
• Documents required for filing ITR
• Which ITR to file for income from mutual funds?
• How to show mutual fund investment in ITR?

What are the types of income from mutual funds?

But before we learn about ITR, we must understand the different types of income/gains generated from mutual funds and rules that govern its disclosure. Here are the broad buckets:

IDCW Income

This is the income that can be released by mutual funds to investors who have opted for the Income Distribution cum Capital Withdrawal (IDCW) plan. This was earlier called the dividend plan, and for taxation purposes, these are taxed as dividends.

Capital gains

Capital gains are profits earned when units of a mutual funds are sold at a higher price than the cost of purchase. There are two types of capital gains:

Short-term capital gains (STCG): Gains realised by selling off units held for less than the period specified for the type of fund. For example, gains from equity-oriented funds are STCG if units are held for less than 12 months.

Long-term capital gains (LTCG): Gains realised if equity oriented fund units are sold after being held for more than the specified period (12 months for equity-oriented mutual funds).

Under the latest tax rules, gains from all debt funds are classified as STCG irrespective of the holding period.

How are mutual funds taxed?

Taxation of IDCW payouts

Before 2020, IDCW income from mutual funds was tax-free as fund houses paid Dividend Distribution Tax (DDT). However, after 2020, DDT was removed, and the income is now taxed at the hands of investors based on their income tax slab. It is filed under ‘Income from Other Sources’.

Additionally, fund houses deduct a 10% TDS (Tax Deducted at Source) under Section 194K of the Income Tax Act, 1961, if the total payout to an investor exceeds Rs. 5,000 in a financial year. Investors can also claim the deducted TDS while filing their income tax return and only pay the remaining tax liability.

Taxation of capital gains provided by mutual funds

Capital gains depend on the type of mutual fund and the holding period of the investment. The holding period refers to the time between buying and selling mutual fund units (as discussed above). Here’s how the taxation of capital gains for different fund types happens as per Budget 2024.

Equity funds and equity-oriented funds

• STCG is taxed at 20% for units held for less than 12 months.
• LTCG is tax-free up to Rs. 1.25 lakh per financial year. Gains above this threshold are taxed at 12.5% without indexation benefits.

Debt funds and debt-oriented hybrid funds

• Gains from all debt funds are categorised as STCG for taxation purposes regardless of the holding period. They are added to the investor’s total income and taxed at the applicable slab rate.

Taxation of capital gains provided by hybrid funds

Hybrid funds are taxed based on their equity exposure:

• Funds with over 65% equity exposure are taxed like equity funds.
• Funds with less than 65% equity exposure are taxed like debt funds.

Securities transaction tax (STT)

• STT is a separate tax applied when buying or selling units of equity funds or equity-oriented hybrid funds.
• The STT rate is 0.001%.
• STT is not applicable to the sale of debt fund units.

Tax benefits in mutual funds

Equity Linked Savings Schemes (ELSS) is an equity mutual fund category that offers tax benefits under Section 80C of the Income Tax Act, 1961, Old Regime. Under this section, investments of up to Rs. 1.5 lakh made in one or more applicable avenues can be deducted from an individual’s taxable income. The avenues listed under Section 80C of the Income Tax Act, 1961, include but are not limited to:

• ELSS mutual funds
• Public Provident Fund
• Sukanya Samriddhi Yojana
• Tax saving fixed deposits

This makes ELSS mutual funds suitable for those seeking tax benefits as well as long-term growth potential through equity investments. However, they have a lock-in period of three years (which is the shortest among all Section 80C of the Income Tax Act, 1961 options).

What are the rules to disclose mutual fund income in ITR?

When filing ITR for mutual fund investments, ensure accurate disclosure of all income types:

• IDCW income: Report under "Income from Other Sources."
• Capital gains: Separate disclosure is needed for STCG and LTCG under the "Capital Gains" section.

Exempt income: Include tax-exempt income for transparency. Failure to disclose income can result in penalties or legal action.

Documents required for filing ITR

• Annual consolidated statement: Obtained from mutual fund houses or registrar and transfer agents. Shows all transactions and redemptions.
• Capital gains statement: Highlights taxable capital gains (STCG and LTCG).
• Form 26AS: Reflects TDS, if applicable.
• Bank account statements: Helps verify IDCW payouts and transactions.
• PAN and Aadhaar Card: Mandatory for filing.

Which ITR to file for income from mutual funds?

ITR-1 (Sahaj): For individuals with total income up to Rs. 50 lakh and do not have any capital gains to report.

ITR-2: For individuals who have earned capital gains, including from mutual funds.

ITR-3: Suitable for those with business income in addition to capital gains.

How to show mutual fund investment in ITR?

• Log in to the income tax portal: Use your PAN/Aadhaar and password to access your account.
• Choose the correct ITR form: Based on your income sources and nature of income.
• Report IDCW income: Under the "Income from Other Sources" section.
• Disclose capital gains: Fill in the "Capital Gains" section with details of STCG and LTCG.
• Attach supporting documents: Upload capital gains and transaction statements, if required.
• Check forms 26AS and AIS to verify details about income, tax payments and TDS.
• Review and submit: Double-check all entries before e-verifying and submitting the return.

Conclusion

Filing ITR for mutual fund investments may initially appear complicated, but a structured approach simplifies the process. Maintain accurate records, disclose all types of income, and consult a tax expert if needed. Proper filing ensures compliance with tax regulations and helps you leverage mutual fund tax benefits effectively.

FAQs:

Which ITR should be filed for capital gains on mutual funds in ITR?

For capital gains from mutual funds, use ITR-2 if you do not have business income. If you also have business or professional income, choose ITR-3.

Under which section of the Income Tax Act is mutual funds income in ITR taxed?

Mutual fund capital gains are taxed under Section 112A for LTCG and Section 111A for STCG of the Income Tax Act, 1961. Additionally, IDCW payouts are taxed under Section 56 (2) in this Act. Additionally, a TDS of 10% is levied on IDCW payouts exceeding Rs. 5,000 in a financial year under Section 194K of the Income Tax Act, 1961.

Are capital gains on mutual funds subject to TDS?

No, capital gains from mutual funds are not subject to TDS. However, IDCW payouts exceeding Rs. 5,000 annually attract TDS at 10%.

Where to show mutual fund income in ITR-1?

In ITR-1, you can report IDCW income under "Income from Other Sources." However, ITR-1 cannot be used to report capital gains.

What are the consequences of not showing mutual fund income in ITR?

Failing to disclose mutual fund income can result in penalties, interest on unpaid taxes, and scrutiny by tax authorities, potentially leading to legal consequences.

What is TDS (Tax Deducted at Source) on mutual fund dividends?

As explained in the article, mutual funds do not pay dividends. Instead, investors can opt to receive payouts whenever the fund house chooses to distribute them under the Income Distribution cum Capital Withdrawal (IDCW) plan. TDS on mutual fund IDCW payouts is applicable at a rate of 10% if the total annual payout exceeds Rs 5,000. Investors can claim a refund while filing ITR if their total tax outlay exceeds the amount they qualify for.

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.