MUTAL INVESTMENT


Taxability of Mutual Fund
The mutual fund trust is exempt from tax. The trustee company however pays tax in the normal course on its profits.
As will be seen, some aspects of taxation of schemes are dependent on the nature of the scheme. The definitions under the Income Tax Act, for the purpose are as follows:
Equity-oriented scheme is a mutual fund scheme where at least 65% of the assets are invested in equity shares of domestic companies. For calculating this percentage, first the average of opening and closing percentage is calculated for each month. Then the average of such value is taken for the 12 months in the financial year.
For Money market mutual funds / Liquid schemes, income tax goes by the SEBI definition, which says that such schemes are set up with the objective of investing exclusively in money market instruments (i.e. short term debt securities).

Securities Transaction Tax (STT)
This is a tax on the value of transactions in equity shares, derivatives and equity mutual fund units. Applicability is as follows:
On equity-oriented schemes of mutual funds
On purchase of equity shares in stock exchange
0.1%
On sale of equity shares in stock exchange
0.1%
On sale of futures in stock exchange
0.01%
On sale of options in stock exchange
0.017%
On investors in equity oriented schemes of mutual fund
On purchase of the units in stock exchange
Nil
On sale of the units in stock exchange
0.001%
On re-purchase of units (by fund)
0.001%
STT is not applicable on transactions in debt or debt-oriented mutual fund (including liquid fund) units.

Additional Tax on Income Distributed
This is a tax on dividend distributed by debt-oriented mutual fund schemes. Applicability of Dividend Distribution Tax (DDT) is as follows:
Individuals and HUF: 25% + Surcharge + Education Cess
Others: 30% + Surcharge + Education Cess
This additional tax on income distributed (referred to in the market as dividend distribution tax) is not payable on dividend distributed by equity-oriented mutual fund schemes.

Capital Gains Tax
Capital Gain is the difference between sale price and acquisition cost of the investment. Since mutual funds are exempt from tax, the schemes do not pay a tax on the capital gains they earn.
Investors in mutual fund schemes however need to pay a tax on their capital gains as follows:
Equity-oriented schemes
 Nil – on LTCG or Long Term Capital Gains (i.e. if investment was held for more than a year) arising out of transactions, where STT has been paid
 15% plus surcharge plus education cess – on STCG or Short Term Capital Gains (i.e. if investment was held for 1 year or less) arising out of transactions, where STT has been paid
 Where STT is not paid, the taxation is similar to debt-oriented schemes
Debt-oriented schemes
 If investment is held for three years or less, the capital gain is treated as Short Term Capital Gains or STCG. It is added to the income of the investor for taxation. Thus, STCG gets taxed as per the tax slabs applicable for the investor. An investor whose income is above that prescribed for 20% taxation would end up bearing tax at 30%. Investors in lower tax slabs would bear tax at lower rates. Thus, what is applicable is the marginal rate of tax of the investor.
 If investment is held for more than three years, the capital gain is treated as Long Term Capital Gain or LTCG. Investor is entitled to the benefit of indexation on LTCG.
Indexation means that the cost of acquisition is adjusted upwards to reflect the impact of inflation. The government comes out with an index number for every financial year to facilitate this calculation. Indexation benefit is available only in case of long term capital gains and not short term capital gains. Tax is payable on long-term capital gains, after indexation, at 20% plus surcharge plus education cess.
 

Tax Deducted at Source (TDS)
There is no TDS on the dividend distribution or re-purchase proceeds to resident investors. However, for certain cases of non-resident investments, with-holding tax is applicable. The income tax regulations prescribe different rates of withholding tax, depending on the nature of the investor (Indian / Foreign and Individual / Institutional), nature of investment (equity / debt) and nature of the income (dividend / capital gain).
Further, Government of India has entered into Double Taxation Avoidance Agreements (DTAA) with several countries. These agreements too, specify rates for Withholding Tax.
The withholding tax applicable for non-resident investors is the lower of the rate specified in the income tax regulations or the tax specified in the DTAA of the country where the investor is resident. The investor, however, will need to satisfy the mutual fund that he is entitled to such concessional rate as is specified in the DTAA.
 

Taxability of Mutual Fund Investor
Based on the above discussions, it can be summarized that:
 An investor in an equity-oriented mutual fund scheme
o Would pay STT on the value of the transactions of sale (0.001%) of units in the stock exchange; or on re-purchase (0.001%) of the units by the fund
o Would be exempt from capital gains tax, if the units were held for more than a year
o Would pay capital gains tax at 15% plus surcharge and education cess, if the units were held for 1 year or less
o Will receive any dividend free of tax; the scheme too will not incur any tax on the dividend distribution.
 An investor in a debt-oriented mutual fund scheme
o Would not bear any STT
o Would bear a tax on long term capital gains at 20% with indexation
o Would bear a tax on short term capital gains, as per the investor’s tax slab.
o Will receive any dividend free of tax; but the scheme would have paid a tax on the dividend distribution. This can be avoided by opting for the growth option of a debt scheme.
 

Setting off Gains and Losses under Income Tax Act
The Income Tax Act provides for taxation under various heads of income viz. salaries, income from house property, profits & gains of business or profession, capital gains, and income from other sources. In the normal course, one would expect that a loss in one head of income can be adjusted (“set off”) against gains in another head of income, since a person is liable to pay tax on the total income for the year. However, there are limitations to such set-off. A few key provisions here are:
 Capital loss, short term or long term, cannot be set off against any other head of income (e.g. salaries)
 Short term capital loss is to be set off against short term capital gain or long term capital gain
 Long term capital loss can only be set off against long term capital gain
 Since long term capital gains arising out of equity-oriented mutual fund units is exempt from tax, long term capital loss arising out of such transactions is not available for set off.
Several other factors go into taxation or tax exemption. If one is not an expert on the subject, it would be better to engage the services of a tax consultant.
 

Limitations on Set-off in case of Mutual Fund Dividends
 When a dividend is paid, the NAV (ex-dividend NAV) goes down.
 Dividend is exempt from tax at the hands of investors
 Capital loss may be available for set off against Capital gains.
A potential tax avoidance approach, called dividend stripping, worked as follows:
 Investors would buy units, based on advance information that a dividend would be paid.
 They would receive the dividend as a tax-exempt income. Equity schemes, as seen earlier, do not beat the additional tax on income distributed.
 After receiving the dividend, they would sell the units. Since the ex-dividend NAV would be lower, they would book a capital loss (with the intention of setting it off against some other capital gain).
In order to plug this loophole, it is provided that:
 if, an investor buys units within 3 months prior to the record date for a dividend, and
 sells those units within 9 months after the record date,
any capital loss from the transaction would not be allowed to be set off against other capital gains of the investor, up to the value of the dividend income exempted.
 

Wealth Tax
Investments in mutual fund units are exempt from Wealth Tax. This is irrespective of where the fund invests. Although investment in physical gold or real estate may attract wealth tax in case of direct investors, investments in Gold ETF and real estate mutual funds are exempt from wealth tax.