The Indian investment landscape is evolving, with increasing interest in financial markets and the potential growth opportunities they offer. Mutual fund assets are growing, and Systematic Investment Plans (SIPs) are generating increasing interest from investors.
As the industry expands, it is important for retail investors seeking potential growth and diversification to be aware of taxation rules. This can help them optimise investment outcomes over time by reducing tax liability.
This article explores taxation through the lens of one mutual fund category – multi cap mutual funds – an equity mutual fund that offers broad market exposure and diversification through a single investment. Read on to learn more about multi cap mutual funds and multi cap fund taxation in India, including dividend taxation, indexation laws, short-term and long-term capital gains, and tax liability reduction techniques.
Table of Contents:
What is SGX Nifty?
A multi cap fund is a type of equity mutual fund that invests across large cap, mid cap and small cap stocks. As per SEBI guidelines:
- 75% of a multi cap fund’s portfolio must be invested in equity or equity-related instruments
- A minimum of 25% must be allocated to large cap companies, 25% to mid cap companies, and 25% to small cap companies.
These rules ensure that the fund maintains consistent exposure to all three market segments.
Through this allocation, the fund seeks to the combine relative stability of large caps with the higher growth potential of small and mid caps and navigate different market cycles.
How are multi cap funds taxed in India?
In India, multi cap fund taxation is subject to the same taxation rules as equity-oriented mutual funds. The tax rate is calculated based on the multi cap fund holding period. Here is an overview:
- For mutual funds, capital gains and Income Distribution cum Capital Withdrawal (IDCW) payouts are taxable.
- Capital gains are taxed upon redemption of units. All potential profits from the sale of units are subject to capital gains tax.
- For units sold after a holding period of less than 12 months, short-term capital gains tax (STCG) is applied. The tax rate is 20%.
- Gains are treated as long-term capital gains (LTCG) if the investor holds the units for more than 12 months. This tax treatment is more favourable than the STCG rate.
- LTCG of up to Rs. 1.25 lakh in a financial year is tax-exempt. Thereon, the tax rate is 12.5%.
- Any applicable surcharge and cess are levied over and above this for both STCG and LTCG.
Read Also: Multi Cap Funds for Diversified Investment Portfolio
Is there indexation benefit in multi cap fund taxation?
There is no indexation benefit on multi cap funds.
Indexation is a method used to adjust the purchase price of an asset (like mutual fund units or real estate) for inflation, so that when you sell it, you are taxed only on the real gains.
This is because inflation increases costs over time. So even if the amount you receive when you sell an asset is higher than what you paid, it’s real-world value may be lower. Indexation helps account for this by adjusting your original purchase cost for inflation, which is determined using a government inflation index – typically, the Cost Inflation Index of CII. This helps ensure you're taxed only on the portion of your gains that represents real growth.
However, there is currently no indexation benefits on mutual funds.
IDCW taxation in multi cap mutual funds
Under the IDCW plan – earlier called dividend plan – an investor can potentially receive periodic income from their mutual fund scheme (though this is not guaranteed).
Potential IDCW payouts are added to the total income of the investor and is taxed as per their applicable income tax slab. Additionally, 10% TDS is applicable if payouts exceeds Rs. 10,000 in a financial year.
How to calculate tax on multi cap fund returns
To further understand how multi cap mutual fund returns are taxed, let's look at an example.
Assume you invested Rs. 2 lakh in units of a multi cap mutual fund. You made the decision to sell the flats after 15 months. At the time of selling, your investment is worth Rs. 3.5 lakh . A profit (capital gain) of Rs. 1.50 lakh is the outcome of this.
Let's now examine the tax on multi cap mutual funds that applies to this profit:
Step 1: Verify the multi cap fund holding period
The profits in this case would be considered long-term capital gains (LTCG) since the units were held for 15 months.
Step 2: Determine the amount that is excluded
LTCG is tax-exempt up to Rs. 1.25 lakh per fiscal year under the present tax regulations.
In this instance, Rs. 1.25 lakh of the Rs. 1.50 lakh gain is tax-free.
Step 3: Determine the taxable profits
Taxable LTCG is equal to Rs. 1.50 lakh less Rs. 1.25 lakh , equal to Rs. 25,000.
Step 4: Use the tax rate for LTCG
LTCG is subject to a 12.5% tax. Therefore, 12.5% of Rs. 25,000 results in Rs. 3,125 in tax.
If, in the above scenario, the units were held for less than 12 months, then the gains would be deemed short-term capital gains. In this case the tax outgo would be 20% of Rs. 1.50 lakh (with no exemption), which means Rs. 30,000.
Thus, holding equity investments for a longer period can significantly reduce the tax outgo.
Example for illustrative purposes only.
Tips to reduce tax liability in multi cap funds
- Hold the fund for more than 12 months to receive a tax exemption of Rs. 1.25 lakh and the favourable LTCG tax rate of 12.5%.
- Consider tax loss harvesting. This is a strategy where you sell loss-making investments to offset gains from other investments. This can potentially reduce overall taxable capital gains and thus lower the total tax liability. However, this strategy must be used after careful consideration of your goals.
- Keep capital gains within the exemption limit. Planning your redemptions such that your capital gains are below Rs. 1.25 lakh in a financial year can help you save on taxes. If possible, spread your redemptions over multiple financial years to reduce tax exposure.
- Choose IDCW plan only if you need income. Mutual funds offer two plans, growth and IDCW. Under the growth option, all potential profits are reinvested into the fund. This can enhance long-term growth potential and enhance opportunities for compounding. IDCW payouts reduce the fund’s net asset value and adds to your tax liability, so it may not suit investors seeking the potential for long-term wealth accumulation.
Multi cap fund taxation vs other mutual fund categories
The three main types of mutual funds—equity, debt, and hybrid—have different taxation structures.
As explained, equity mutual funds are subject to 20% tax on short-term capital gains from units sold within a year and 12.5% tax on long-term capital gains from units held after a year, with gains up to Rs. 1.25 lakh exempted every fiscal year.
Debt mutual funds: These funds are subject to a distinct taxation regime because they invest in fixed-income assets. Under the latest tax rules, gains from debt fund investments made after April 1, 2023 are treated as short-term regardless of the holding period, and taxed at the investor’s applicable slab rate. Before April 2023, debt funds used to offer indexation benefit on long-term capital gains tax, but this is no longer the case.
Hybrid funds: Taxation on gains arising from sale of hybrid mutual fund units are determined by the fund’s equity exposure. Funds with over 65% equity exposure are taxed as equity-oriented funds. Funds with less than 35% equity exposure are treated as debt funds for taxation purposes, and investors are taxed at their applicable slab rate.
For hybrid funds with more than 35% but less than 65% equities, short-term capital gains are taxed as per slab rate and LTCG rate is 12.5% with no exemption. In the case of such funds, the holding period to qualify for LTCG is 24 months.
Read Also: How Suitable Are Multi Cap Funds For Retirement
Conclusion:
To sum up, a multi-cap mutual fund is a diversified investment option that invests in listed companies of all sizes to balance risk while focusing on long-term growth potential. To get optimal return potential from your investments, understanding taxation is key, because it influences your net returns. Holding a long-term view, keeping gains close to the exemption limit and planning redemptions carefully can help optimise post-tax growth potential over time.
FAQs:
What is the tax rate on multi cap mutual fund returns?
After an annual exemption of Rs. 1.25 lakh, long-term profits (>12 months) are taxed at 12.5%, while short-term gains (≤12 months) are taxed at 20%.
Is indexation available for multi cap funds?
Multi cap mutual fund returns are categorised as equity-oriented and are not eligible for indexation benefits.
How long should I hold a multi cap fund to get long-term tax benefits?
To be eligible for long-term capital gains tax on multi cap funds, you must hold multi cap mutual fund units for more than 12 months.
Are dividends from multi cap funds taxable?
The term ‘dividend’ no longer applies to mutual funds; the plan is now called Income Distribution cum Capital Withdrawal. IDCW payouts, if any, released in a financial year are added to your annual income and taxed according to your income tax slab. Additionally, if your total payouts for a financial year exceed Rs. 10,000, 10% TDS is applied.
Can tax-saving be done through multi cap funds?
No, only ELSS mutual funds are eligible for tax deductions under Section 80C of the Income Tax Act, 1961, under the old regime. However, multi cap funds are taxed at lower LTCG rates if units are held for over 12 months and LTCG of up to 1.25 lakh in a financial year are tax-exempt.
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