January 07 , 2013
Equity mutual funds are must-haves for anybody investment portfolio. They invest in equity shares of companies and over time make your investments grow in sync with the markets. And to make things better they are also the most tax-friendly of all types of mutual funds.
Rationale for lower tax treatment of Equity MFs
In the long term it is equities that bring real growth since they are directly linked to how businesses are doing. When businesses do well they bring economic prosperity. Therefore the government would like to encourage retail investors to channel their investments in equities rather than pile them up in fixed deposits or bonds. One way it does this is by treating equity and equity-linked investments leniently compared to investments in debt products, when it comes to tax.
Tax implication of Equity MFs
Tax is always charged on income made. There are two ways of getting income in equity mutual funds, that is through i.dividends and ii.capital gains.
i. Tax on equity mutual funds dividends
Dividends attract a Dividend Distribution Tax. Presently it is the mutual fund company who is liable to pay it (though the truth is ultimately they charge it on the investors). But in any case equity mutual funds are exempted from this tax, so no worry for you!
ii. Capital gains tax on equity mutual funds
You make capital gains when you sell a capital asset for profit. Mutual funds are capital assets. However capital gains tax is not uniform for all sorts of gains. For any asset to give real returns arising from growth you need to give sufficient time. Quick returns mostly result from speculation or pricing imbalances. Therefore like you would have already figured, long term gains are treated favourably than short term gains. You pay this tax in the year you made the gain.
Short term capital gains (STCG) on equity MFs
If you sell your units before one year of buying them you have a short term capital gain. Here the tax is a flat 15.45% of the gain. This is lower than STCG on other types of mutual funds where youre required to pay tax as per tax slab you come under.
Long term capital gains (LTCG) on equity MFs
Now comes the biggest treat. When you sell equity mutual fund units any time after one year of buying them the LTCG is- zero! Of course, this special treatment is limited to equities (shares and equity MFs).
The above tax treatment of equity mutual funds applies for resident investors as well as non-resident investors (NRIs). Tax treatment of equity oriented mutual funds (funds having 65% or more allocation in equities) is similar.