Mutual funds are a widely used investment vehicle, but one must know their tax implications while submitting income tax returns. Tax on mutual funds varies based on holding period, type of fund, and treatment of dividend or capital gain. Timely filing of tax returns makes one complacent and does not invite penalty.

This article explains taxation of mutual funds in India, filing process, and reducing tax liability and remaining tax compliant.

Taxation of Mutual Funds in India

Mutual funds are taxed depending on the fund type and length of the holding period for which the investment has been held.

1. Tax on Capital Gains on Mutual Funds

Capital Gains Tax on Mutual Funds

Capital gains are the profits made when units of a mutual fund are sold or switched between schemes at a price greater than their cost. The taxability depends on the holding period:

Equity Mutual Funds (Investing 65% and more in listed equities)

• Short-Term Capital Gains (STCG): If sold within one year or less, charged at 20%.
• Long-Term Capital Gains (LTCG): On its sale after one year, income in excess of ₹1.25 lakhs will be charged at 12.5% (without indexation).

Debt Mutual Funds (Altered from April 1, 2023)

• Gains on debt mutual funds, acquired on or after April 1, 2023, regardless of the holding period, are taxed at slab rates.
• Gains on debt mutual funds, acquired before April 1, 2023, are taxed at 12.50% (without indexation), if they are held for more than 12 months.
• Previously, long-term capital gains (LTCG) on debt funds with more than three-year holding were charged at 20% with indexation relief. Not anymore.

Hybrid or Balanced Funds

• If they are exposed to more than 65% equity, they will be treated as equity funds.
• If they are exposed to more than 65% debt and money market instruments, they will be treated as debt funds.
• In any other case, they will be treated as normal funds and taxed at 12.50%, if they are held for more than 24 months or at slab rates if held for 24 months or less.

Tax on Mutual Fund Dividends

• Earlier, until April 1, 2020, dividends were not taxed to the investor but were charged Dividend Distribution Tax (DDT) at the AMC level.
• Dividends are taxed as part of taxable income and based on the income tax slab of the investor.
• 10% TDS on dividends over ₹5,000 in a financial year.

How to Report Mutual Fund Income in ITR?

Mutual fund income must be disclosed under Income from Other Sources or Capital Gains, depending on the nature of income whether dividend income or realized capital gains.

1. Choosing the Right ITR Form

• ITR-2: For individual taxpayers with capital gains in mutual funds.
• ITR-3: For business taxpayers with capital gains.
• ITR-1: Not to be used if there are tax payable capital gains.

2. Reporting Mutual Fund Gains in ITR

• Download Form 26AS and AIS from the Income Tax website to check TDS and income credited.
• Strike capital gain statements (STCG/LTCG for debt/equity schemes).
• Fill in full details in the Capital Gains Schedule of the ITR form.
• Add a deduction for advance tax paid or TDS deducted on dividends.
• Verify and file ITR prior to the due date.

Tax-Saving Options for Mutual Fund Investors

Investors can save tax through the following options:

1. Tax Save by Investing in ELSS

• Equity-Linked Savings Schemes (ELSS) provide tax relief of up to ₹1.5 lakh under Section 80C an old tax regime.
• 3-year lock-in period.

2. Utilize Capital Gains Exemptions

• LTCG up to ₹1.25 lakh is exempt from tax for equity mutual funds.
• Offset capital losses against gains in order to lower the tax burden.
• Basic exemption limit of ₹2.5 lakhs/₹3 lakhs can be utilized if there is no other income.

3. Redemptions Planning

• Redemptions staggered over a couple of financial years can assist in keeping the exemption threshold intact and surcharge benefits.
• Avoidance of frequent redemptions to limit STCG tax.

4. Tax Harvesting Plan

• Pre-mature redemption of mutual fund units prior to reaching the LTCG exemption threshold of ₹1.25 lakhs and re-investment later to rebase the cost of acquisition.
• Reduces the weight of long-term capital gains tax.

Mistakes to Avoid while Filing ITR for Mutual Funds:

• Missing to report capital gains on SIP redemptions.
• Missing to report dividend income and receiving a tax notice.
• Inappropriately choosing the wrong ITR form.
• Not cross-verifying and e-filing returns within the due date.
• Missing to deduct TDS in calculating tax liability.

Understanding the taxation of mutual funds helps investors make informed financial decisions. By having the right tax filing strategy, reporting exemptions, and avoiding potential mistakes, investors can stay compliant as well as optimize tax outflow.

To begin filing your taxes, you may visit the official Income Tax e-filing portal here: Income Tax e-filing portal.

FAQs for Income Tax Filing of Mutual Funds

• Is TDS on mutual fund returns deducted?
  No, TDS isn't due on capital gains. But 10% TDS is due on dividends of ₹5,000 or above per year.
• Do I have to pay tax on SIP investment?
  No, SIP investment isn't tax-deductible, but SIP withdrawal capital gains are subject to STCG/LTCG regulations.
• Can I offset losses against gains?
  Yes, the short-term losses are to be adjusted against both STCG and LTCG, and the long-term loss is to be adjusted against LTCG.
• Which ITR form do I use to report mutual fund gains?
  Use ITR-2 to report mutual fund capital gains.
• How do I save tax on mutual fund investments?
  Tax saving is possible by investing in ELSS funds (Section 80C), redeeming at the right time, and offsetting capital losses.
• What happens if I don't report mutual fund gains?
  You can be cautioned for tax by the Income Tax Department in case of failure to report capital gains. It is advisable to update your ITR, if required.
• Can mutual fund investment be taxed on refund?
  Yes, in the situation of excess TDS deduction or excess advance tax payment, you can get a refund by filing the correct ITR.