How Are Mutual Funds Taxed in 2024? Key Rules Explained

Mutual funds are an attractive investment avenue for a diverse range of investors in India, including individuals and Hindu Undivided Families (HUF). As of 2024, the taxation on mutual funds in India is influenced by several factors such as the type of fund, the holding period, and the Income Tax Slab applicable to the investor. This article delves into the intricacies of how mutual funds are taxed, the considerations for HUFs, and provides practical examples to elucidate the key rules.

Taxation Based on Type of Mutual Fund

Mutual funds are broadly categorized into equity-oriented funds and non-equity (debt) funds, and each category is taxed differently.

1. Equity-Oriented Mutual Funds: These are funds with at least 65% investment in equities.

• Short-Term Capital Gains (STCG): If equity fund units are held for less than 12 months, profits are taxed at 15% plus applicable surcharge and cess.

• Long-Term Capital Gains (LTCG): If held for more than 12 months, the gains exceeding INR 1 lakh in a financial year are taxed at 10% without the benefit of indexation.

2. Non-Equity (Debt) Mutual Funds: These funds primarily invest in non-equity instruments.

• Short-Term Capital Gains (STCG): Gains on units held for less than 36 months are added to the investor’s income and taxed as per their respective Income Tax Slab.

•  Long-Term Capital Gains (LTCG): Gains on units held for more than 36 months are taxed at 20% with the benefit of indexation.

Taxation for HUFs and Individuals

HUF, similar to individual investors, need to adhere to the Income Tax Slab pertaining to them when deriving income from investments, including mutual funds. HUFs can avail of income tax slabs separately, and as such, they need to calculate their tax liability accordingly.

Income Tax Slabs for FY 2024-25

While discussing mutual funds taxation, awareness of the prevailing Income Tax Slab is crucial. Though typically updated every financial year, the tax slabs for 2024-25 are as follows for individuals below 60 years and HUFs under the new regime:

- Up to INR 2.5 lakh: Nil

- INR 2.5 lakh to INR 5 lakh: 5%

- INR 5 lakh to INR 7.5 lakh: 10%

- INR 7.5 lakh to INR 10 lakh: 15%

- INR 10 lakh to INR 12.5 lakh: 20%

- INR 12.5 lakh to INR 15 lakh: 25%

- Above INR 15 lakh: 30%

Illustrative Example

Consider an investor who earned a LTCG of INR 1.5 lakh from an equity mutual fund during the year. Under the current rules:

- The first INR 1 lakh is exempt from tax.

- The remaining INR 50,000 is taxed at 10%, resulting in a tax liability of INR 5,000.

If the same investor realizes a STCG of INR 50,000 in an equity fund, the tax applicable would be:

- STCG of INR 50,000 × 15% = INR 7,500.

Dividend Distribution Tax (DDT) Replaced by Tax on Dividends

Following the abolition of Dividend Distribution Tax (DDT), dividends from mutual funds are now added to the investor’s income and taxed as per their respective Income Tax Slab. This rule applies uniformly to individuals and HUFs.

Impact of Indexation on Long-Term Debt Funds

For debt mutual funds, indexation allows for the adjustment of the purchase price to account for inflation, reducing the taxable gain. Suppose an investor purchases debt fund units for INR 1 lakh and sells them after three years for INR 1.5 lakh:

- The Cost Inflation Index (CII) for the purchase year is 280, and for the selling year, it is 317.

- Indexed Cost of Acquisition = (CII for selling year / CII for purchase year) × Original purchase cost

= (317/280) × 1,00,000 = INR 1,13,214.

- LTCG = Selling price - Indexed Cost = INR 1,50,000 - INR 1,13,214 = INR 36,786.

Applying 20% LTCG tax: INR 36,786 × 20% = INR 7,357.

Conclusion

Mutual funds offer a versatile investment portfolio, but understanding their tax implications is essential for maximizing gains. The taxation varies based on equity exposure, holding duration, and current tax slabs. For HUFs, mutual funds remain an efficient mode to accumulate wealth, separate from individual income.

Disclaimer: This article is for informational purposes only and should not be construed as financial advice. Investors must assess all benefits and risks associated with trading mutual funds. Consulting a financial advisor or conducting thorough research is recommended before investing in the Indian financial market.

Summary

Mutual funds are a popular investment choice for both individuals and Hindu Undivided Families (HUF) in India. In 2024, their taxation depends on whether the funds are equity or non-equity based, along with the holding period. Equity funds have a short-term capital gains tax at 15% and a long-term tax rate of 10% on gains exceeding INR 1 lakh. Non-equity funds align their short-term gains to the Income Tax Slab, while long-term earnings benefit from indexation, attracting a 20% tax.

The latest Income Tax Slab plays a crucial role in determining the tax liability from dividends. Following the replacement of the Dividend Distribution Tax, dividends are taxed as per the investor's applicable slab. For HUFs, tax planning using mutual funds can efficiently distribute wealth, taking into account the implications of tax policies inherent to mutual funds and HUF separations. Investors need to evaluate all variables carefully before investing in mutual funds.