Mutual funds have various products under its umbrella, but general investors are not aware about taxation aspect and tax implication of investing in mutual funds. This article explains the various aspects of taxation of investment in various schemes of mutual funds.

Holding period

Under the present income tax laws, capital gains are divided into two categories for the purpose of rate and exemptions available. Generally, an asset is treated as long-term if the same has been held by the taxpayer for more than 36 months. However, in case of units, whether listed or unlisted, of any Indian mutual fund, the holding period requirement is lower at 12 months for it being treated as long-term.

Taxation of income from mutual funds

There are two ways in which you earn income from your investment in mutual funds. First, by way of dividends and the other is by appreciation in the NAV of the units of your investment. While investing in mutual funds schemes, you have to choose an option between dividend and growth. In case of growth option, the fund house does not declare and pay any dividend out of its income and consequently the NAV of your investment goes up. Both the options have its tax implication for you. Let us understand the implication of choosing dividend option or growth option.

Dividend distribution tax

Dividends received by you from a mutual fund is fully exempt in your hands but are you aware that the certain mutual funds have to pay a tax called dividend distribution tax (DDT) on such dividend distributed to you? The cost of which is ultimately borne by the investor only. It is not that every mutual fund house has to pay dividend distribution tax. So equity-oriented schemes that maintain a minimum of 65% investment in equity shares of Indian companies are not required to pay any distribution tax on the dividends distributed.

All other mutual funds schemes have to pay dividend distribution tax at the rate of 25% on the income distributed to an Individual or HUF unit holder. In case recipient of dividends is other than HUF or Individual, the applicable rate of dividend distribution tax is 30%. So the DDT thus effectively reduces your return on investment.

Capital gains tax

Any profit made on sale or redemption of your mutual fund scheme is taxed as capital gains. In case the units sold are held for not more than 12 months, the profit on such units is treated as short-term capital gains. The treatment of short-term gains on mutual funds will depend on whether the units sold are of equity-oriented scheme or other schemes. Short-term capital gains made on sale of equity-oriented schemes is taxed at the rate of 15.45% whereas any short-term capital gains on any other scheme is treated like your other income and taxed at the slab rate applicable to you.

Any long-term capital gains made on equity-oriented scheme are fully tax exempt, but for long-term capital gains on other schemes, you have two options. Either you can pay tax at a flat rate of 10.30% on the actual profits made on sale of such units. Alternatively, you can opt to pay long-term capital gains tax at the rate of 20.60% on indexed gains in case the plain 10.30% tax is higher.

Growth option versus dividend option

In case you want to park your temporary surplus funds for less than 12 months period in liquid fund or ultra short- term funds, and you are in the highest tax slab of 30%, it makes sense for you to opt for dividend option. Here the rate of DDT is 25% on liquid funds. This is lower than the maximum marginal rate of 30%.

However, in case your time horizon is more than 12 months for investment of your temporary surplus funds, you can opt for growth option irrespective of your applicable tax rate. This way maximum tax liability on any profit made will be 10.30%.

Since you have another option of paying tax at 20.60% on indexed capital gains, and the cost inflation index announced for the past few years is higher than 10%, your long-term capital gains tax liability in liquid funds will be negligible as the return on such schemes are generally not more than 10%. This is the main reason behind popularity of FMPs where, in case the investment is made during the last quarter of the year and redeemed after 15 months, your tax liability is almost nil as you can avail double indexation benefits on such investment.

Likewise for your investment in equity-oriented schemes, you should opt for dividend option as no dividend distribution tax is levied. However, you may have to pay short-term capital gains at the rate of 15.45% in case the units are redeemed or sold within a period of 12 months. For investments beyond 12 months, it does not make any difference whether you choose dividend option or growth option as per the present tax laws.

From the above discussion, I am sure you have full clarity about taxation aspect of investments in various mutual fund schemes. This also must have helped you in understanding as to when should you opt for growth option and when should you go for dividend option for your investment in mutual funds.

The author is CFO, Apna Paisa. The views expressed in this article are his own.

The amount of insurance that one needs depend upon various factors which include age, the ages of spouse and children, income, mortgage and other debts, college/school expenses for children and/or spouse, and the size of the last bill you'll ever incur.

Rule of thumb

In order to determine how much insurance one needs is to consider some or all of the following factors:

I and my wife are retired from the Punjab Government service and drawing pensions. Our son is studying in MBA and we are paying his fee twice a year i.e. every semester amounting to Rs 1,02,500 every semester. Can both of us claim the rebate of Rs 1,00,000 each u/s 80C? We are not senior citizens i.e. not attained the age of 65 years. — Raj Kumar Chaudhari

On the basis of the facts given in your query, it should be possible for each one of you to claim the deduction of the tuition fee paid in respect of your son’s education. This is subject to the proposition that he is studying in India and the amount of fee is paid by each one of you out of his/her bank account. The deduction as pointed out by above is limited to the extent of the amount paid subject to a maximum of Rs 1 lakh per year. It may be added that the amount of Rs 1 lakh is inclusive of all sums paid or deposited in the schemes specified in Section 80C of the Income-tax Act, 1961.

I am entitled to medical reimbursement to the extent of Rs 15,000 per annum. In case I take a mediclaim policy, will the premium paid by me allowable as deduction in spite of my willing the above benefit of medical reimbursement on the basis of my terms of appointment. — Inder Mohan

The deduction allowable under Section 80DD of the Income-tax Act 1961 (the Act) in respect of the premium paid for taking a mediclaim policy is over and above to the reimbursement of medical expenses granted by your employer. Accordingly, you would be entitled to claim the deduction of the premium paid for taking a mediclaim policy without effecting the medical reimbursement to the extent of Rs 15,000 which is exempt from tax liability.

Please let me know how to claim rebate u/s 89. Whether the form 10E is to be submitted to the employer and how the rebate is calculated? If one has not submitted the form 10E, can he claim rebate? — Birender Singh

The rebate under Section 89 of the Income-tax Act 1961 (the Act) can be granted if an individual receives any portion of his salary in arrears or in advance or receives profits in lieu of salary. The rebate can be claimed under the provisions of Section 89 of the Act read with Rule 21A. The requirement of submission of form 10E is contained in Rule 21AA. Rule 21AA requires that an assessee entitled to relief under Section 89(1) of the Act may furnish to the person responsible for making the payment referred to in sub-section (1) of Section 192 of the Act the particulars specified in form 10E. The calculation of the rebate under Section 89 of the Act has to be made as under:

Compute the tax payable on the total income, including the arrears etc., of the relevant previous year in which the same is received.

Compute the tax payable on the total income, excluding the arrears etc., of the relevant previous year in which the additional salary is received.

Ascertain the difference between the tax at (1) and (2).

Compute the tax on the total income after including the arrears etc; in the previous year to which such salary relates.

Compute the tax on the total income after excluding the arrears etc; in the previous year to which such salary relates.

Find out the difference between (4) and (5).

The excess of tax computed at (3) over the tax computed at (6) is the relief admissible under Section 89 of the Act. No relief is admissible if tax at (3) is less than tax computed at (6).

As pointed out above, form 10E is to be filed with the employer. In case the same is not filed with the employer, due relief should be granted by the assessing officer while framing the assessment.