Here is a question that pops into every investor’s mind – how do I tax my profits from shares and mutual funds? You’ll find that answer here. The way your mutual fund or share is treated for tax has a lot to do with the type of investment within your portfolio. On a whole – most distributions that you receive from a mutual fund should be declared as an investment income on your yearly taxes. Still, the type of distribution that has even been received, the tenure of your investment holdings, and the kind of investment are crucial factors to determine how much income tax you would be paying on every rupee you earn through that fund?
The sole objective of any investment is to create wealth. On that note, mutual funds are a great way to reach that objective through capital appreciation. Now, you know that they are without a doubt taxed. So let’s find out more about this as we keep reading. But you also have to remember that these investments are taxed differently from your income. We’ll find out more.
How is Ordinary Income Different from Capital Gains?
The major difference between your ordinary income and the gains you make through Mutual funds is the tax bill. Only if the investment that you get from investments held for more than 1 year, then they are considered to be capital gains. This is a concept that is quite straight, especially when it comes to investing in stocks. Still, the world of Mutual funds is quite different from individual stocks. We can’t just describe it in one line. Let’s understand from scratch.
What are Mutual Funds?
Mutual funds are investment companies that invest in a collective contribution of thousands of shareholders in various securities that are called portfolios. When it comes to distributions, the difference between your general income and capital gains doesn’t have anything to do with the fund that was held as an individual investment in the portfolio.
If you get a distribution from a fund that has come from the sale of security the fund held for only six months, then this income is taxed just like your ordinary income. But, if it was held for several years, then they are subject to capital gains tax. We all dive into investments for the long term. So it is quite necessary to know more than this. Other than that, there is so much more you would have to know about Mutual funds to find out how they will be taxed.
How will your Earn Returns in Mutual Funds?
Mutual funds give you returns in two ways:
1. Dividends
2. Capital Gains
-1. Dividends are paid out as profits of the company if they are any. When these companies are left with a surplus. They could possibly decide to share this with the investors in the form of dividends. While they decide this, the investors get a proportion to the number of Mutual funded units.
-2. Capital gains, on the other hand, are the profits that are realized by investors if the selling price of the security held is greater than the purchase price. In simpler words, it means they are realized due to the appreciation in the price of the mutual funds’ units.
Both of these, whether dividends or capital gains are subject to taxes. Also, you have got to know both of them because you know they have an impactful CAGR ( CAGR Full Form – Compound Annual Growth Rate) that you would soon have to pay taxes for.
Let us look at each of them in-depth.
Tax on Capital Gains of Mutual Funds
If you sell your assets at a profit, then the whole profit that you earn is called a capital gain. Capital gain is the principal investment that was made during the purchase of your mutual fund units.
For instance:-
Assume you have made a purchase of a few units of Mutual funds for Rs. 1,000. Your capital expenditure for this is Rs.1,000. When the fund generates a return of 10%, your fund’s value becomes Rs. 1,100. So, now the capital gain is Rs.100. This is the total income minus the initial capital you had bought it for.
Your Capital Gain, which is Rs. 100 is the Income Income that is going to be taxed.
Also, it’s important that the tax gain is only applicable when the asset is sold. If you continue to be invested in this mutual fund, you wouldn’t have to pay mutual fund gains tax.
Most importantly, the capital gains tax in India depends on the mutual fund scheme and the time you are invested for. So, as previously mentioned- according to the investment type, you would either have to pay long-term capital gains tax or short-term capital gains tax.
Tax on Dividends of Mutual Funds
If you invest in a mutual fund that has a dividend payout, you will be getting payments in the form of a dividend. Whenever there is a profit in this fund, the profit gets distributed among its investors in the form of dividends, depending on the tenure that the investors opt for.
Initially, that is before the year 2020, dividends were not taxable, but now they are. So, fund houses wouldn’t have to pay the dividends Distribution Tax on equity mutual funds and equity. This means, it was fund houses that were taxed for dividends, but after 2020 April, it is the investor on whom the tax falls.
If your dividend is more than Rs. 5000, then it is subject to TDS of 10%. If your PAN is linked to the Aadhaar, it’s 10%, and if not, it becomes 20%. This is something that has driven some investors away from dividend mutual funds.
Conclusion
Hoping you have found this information relevant and useful. Wasn’t that hard after all, was it? All you have to do is to make sure that you understand what you are investing in and how much you would be giving away as taxes on your gains and earnings.
Also read: Financial Planning for Entrepreneurs Starting Their Own Business