Tax Implication on Mutual Funds Investment in India

What is the tax liability on receipt of Income on Mutual Fund Units?

As per Section 10(33) of the Income Tax Act, 1961 (‘Act’) income received in respect of units of a mutual
fund specified under Section 10(23D) is exempt from income tax in India and the mutual funds are subject to
pay distribution tax in debt-oriented schemes. Hence all dividends are tax-free in the hands of non-resident
investors and no TDS is applicable on the same.

Equity Oriented Funds- As per section 115T of the income tax Act, Equity Schemes are
defined as Scheme which have greater than 65% 'average' investments in Equity
shares of domestic companies.

Tax Implication on Capital Gains:

Short Term Capital Gains:
Units held for not more than twelve months preceding the date of their transfer are short term capital assets.
Gains arising from the transfer of such funds are referred to as Short Term Capital Gains.

(i) On the units of Equity Oriented Funds- Under section 111A and section 115D of the act, Short Term
Capital Gains arising out of Equity Oriented Funds are charged at 15% to all the investors including
Residential Investors, HUF Investors, Partnership Firms, Domestic Firms, AOP/BOI, NRI and PIO. The said
tax rate may increase by surcharge if applicable.

(ii) On the units of Other than Equity Oriented Funds-

(a) The income arising out of the transfer of other than equity oriented funds would be considered as the
normal income of the investor and would reflect in the income tax slab of the investor.

(b) The FII’s will be charged at 30% u/s 115AD of the act, without the benefit of indexation.

Long Term Capital Gains:

Units held for more than twelve months preceding the date of their transfer are long term capital assets.
Gains arising from the transfer of such funds are referred to as Long Term Capital Gains.

(i) On the units of Equity Oriented Funds- As per section 10(38) of the Act, any income arising from the
transfer of a long term capital asset being a unit of an Equity Oriented Scheme shall not form part of total
income, therefore, exempt from Income Tax.

(ii) On the units of Other than Equity Oriented Funds-

(a) For Resident Unit Holders- Any long term capital gain arising on redemption of units by residents is
subject to treatment indicated under Section 48 and 112 of the Act. Long term capital gains in respect of units
held for more than 12 months is chargeable to tax @ 20% after factoring the cost inflation index or tax at the
rate of 10% without indexation, whichever is lower. The said tax rate is to be increased by surcharge, if
applicable.

(b) For Non- Resident Unit Holders- Under section 115 E of the Act, in case of income of non resident
Indians by way of long term capital gains, in respect of units is chargeable at the rate of 20% plus surcharge,
if applicable. Under section 115 D of the Income Tax Act, a non-resident Indian cannot avail the benefit of
indexation.

(c) For FII’s, as per section 115 AD of the Act, long term capital gains on sale of units are to be taxed @
10%.
Note: Such gains in either case would be calculated without indexation benefit as the first and second
provisions to section 48 do not apply to FIIs by virtue of section 115 AD (3) of the Act. The applicable tax
rates are to be increased by applicable surcharge.
 DDT (Dividend Distribution Tax)

All the dividends announced by the Mutual Funds are tax free. Only when the dividend is distributed
by the Mutual Funds to the investors, the Mutual Funds have to pay a Dividend Distribution Tax.
Although the dividend received in the hands of the investors are tax free the burden of the DDT is
indirectly borne by the investors as the dividend which they receive are tax deducted dividends.

Following are the different DDT applied to different categories of investment:

(i) On the units of Equity Oriented Funds- The Dividend Distribution Tax is Nil for all the
investments receiving dividend under Equity Oriented Funds.

(ii) On the units of other Equity Oriented Funds-

(a) Individuals and HUF- DDT is taxed at 12.5%+ 10% Surcharge+ 3% Education Cess (2% + 1%
Secondary and Higher Education Cess on income and surcharge). This sums up total to 14.1625%.

(b) Others- DDT is taxed at 20%+ 10% Surcharge+ 3% Education Cess (2% + 1% Secondary and
Higher Education Cess on income and surcharge). This sums up total to 22.66%.

(iii) Money Markets & Liquid Funds- Here DDT is same for all types of investors, i.e. DDT is taxed
at 25%+ 10% Surcharge+ 3% Education Cess (2% + 1% Secondary and Higher Education Cess on
income and surcharge). This sums up total to 28.325%.

ELSS

Section 80C of Income Tax Act Benefits through ELSS:

Under the current tax laws, you can get an annual income tax benefit of up to Rs. 1Lakh if you invest
in Equity Linked Savings Schemes, ELSS. However, the minimum term for these schemes is 3 years
and you cannot withdraw your money before that time. Thus, a person falling under the tax bracket of
30% can save a tax of Rs.30000 annually.
 TDS (Tax Deductable at Source)

TDS on Equity Oriented Units

(i) Resident Investors

As per Central Board of Direct Taxes (‘CBDT’) circular No.715 dated 8th August 1995, in case of
resident unitholders no tax is required to be deducted from capital gains arising at the time of
redemption of the units.

(ii) For Non Resident Investors

Long Term Capital Gains:

No tax is deductible from the proceeds payable to non resident investors from long term capital gains
arising out of redemption of units of an equity oriented fund.

Short Term Capital Gains:

As per Part II of the First Schedule to the Finance Act 2008 {Clause 1 (b) (i) (C)}, the Mutual Fund is
liable to deduct tax @ 15% on short term capital gains. The TDS is to be increased by applicable
surcharge.

(iii) In the case of a Company

Other than a Domestic Company:

Long Term Capital Gains:

No tax is to be deducted from the proceeds payable to non resident investors from long term capital
gains arising out of redemption of units of an equity oriented fund.

Short Term Capital Gains:

As per Part II of the First Schedule to the Finance Act 2008 {Clause 2 (b) (vii)}, the Mutual Fund is
liable to deduct tax @ 15% on short term capital gains. The TDS will have to be increased by
applicable surcharge.

(iv) Foreign Institutional Investors (FIIs):

In the case of Foreign Institutional Investors (FIIs), no tax would be deductible at source from the
capital gains arising on redemption of units in view of section 196 D (2) of the Act.

TDS on other than Equity Oriented Units:

(i) Resident Investors

As per Central Board of Direct Taxes (‘CBDT’) circular No.715 dated 8th August 1995, in case of
resident unitholders no tax is required to be deducted from capital gains arising at the time of
redemption of the units.

(ii) for Non Resident Investors

Long Term Capital Gains

As per Part II of the First Schedule to the Finance Act 2008 {Clause 1 (b) (i) (D)}, the Mutual Fund is
liable to deduct tax @ 20% on long term capital gains.

Short Term Capital Gains

As per Part II of the First Schedule to the Finance Act 2008 {Clause 1 (b) (i) (K)}, the Mutual Fund is
liable to deduct tax @ 30% on short term capital gains.
Further an education cess @ 2% and secondary and higher education cess @1% is to be charged on
amount of tax and surcharge mentioned above.

(iii) Other than a Domestic Company:

Long Term Capital Gains

As per Part II of the First Schedule to the Finance Act 2008 {Clause 2 (b) (viii)}, the Mutual Fund is
liable to deduct tax @ 20% on long term capital gains.

Short Term Capital Gains

As per Part II of the First Schedule to the Finance Act 2008 {Clause 2 (b) (ix)}, the Mutual Fund is
liable to deduct tax @ 40% on short term capital gains.

(iv) Foreign Institutional Investors (FIIs):

In the case of Foreign Institutional Investors (FIIs), no tax would be deductible at source from the
capital gains arising on redemption of units in view of section 196 D (2) of the Act.

TDS on Income of Units:

As per the provisions of section 194 K and section 196A of the Act, where any income is credited or
paid on or after 1st April 2003 by a Mutual Fund, no tax is required to be deducted at source.
 STT (Security Transaction Tax)

Securities Transaction Tax ("STT") is applicable on transactions of purchase or sale of units of Equity
Oriented Fund entered into on a recognised stock exchange or sale of units of Equity Oriented Fund
to the Mutual Fund.

The Finance Act, 2006 has revised the rates for levy of STT under Chapter VII of the Finance (No.2)
Act 2004 with effect from June 01, 2006 which are given in the following table:

Taxable Securities Transactions Rate Payable By

Purchase of a unit of an equity oriented fund,
where --
• The transaction of such purchase is entered 0.125% Purchaser
into in a recognised stock exchange; and
• The contract for the purchase of such unit is
settled by the actual delivery or transfer of
such unit.
Sale of a unit of an equity oriented fund, where --
• The transaction of such sale is entered into in
a recognised stock exchange; and 0.125% Seller
• The contract for the sale of such unit is
settled by the actual delivery or transfer of
such unit.
Sale of a unit of an equity oriented fund, where --
• The transaction of such sale is entered into in
a recognised stock exchange; and 0.025% Seller
• The contract for the sale of such unit is
settled otherwise than by the actual delivery
or transfer of such unit.
Sale of unit of an equity oriented fund to the Mutual
Fund itself. 0.25% Seller*

* Mutual Fund is responsible for collecting the STT from every person who sells the unit to it.
 Certain common provisions for equity oriented funds and other than equity
oriented funds

Deductions under Section 80C

Deduction under section 80C is available only to an Individual/HUF on the basis of specified qualifying
investment /contribution /deposits/payment made by tax payer during the previous year. Maximum
amount deductible u/s 80C cannot exceed Rs. 1lakh.

DTAA (Double Tax Avoidance Agreement):

As per CBDT Circular No. 728 dated October 30, 1995, in the case of remittance to a country with
which a DTAA is in force, the tax is to be deducted at the rate provided in the Finance Act of the
relevant year or at the rate provided in the DTAA, whichever is more beneficial to the assessee. For
the unitholder to obtain the benefit of a lower rate available under a DTAA, the unit holder is required
to provide the Mutual Fund with a certificate obtained from his Assessing Officer stating his eligibility
for the lower rate.

Short Term Capital Losses:

As per section 94(7), if any person acquires units within a period of 3 months prior to the record date
fixed for declaration of dividend or distribution of income and sells or transfers the same within a
period of 9 months from such record date, losses arising from such sale to the extent of income
received or receivable on such units, which are exempt under the Act, will be ignored for the purpose
of computing his income chargeable to tax.

Further, as per Section 94(8), where additional units have been issued to any person without any
payment, on the basis of existing units held by such person then the loss on sale of original units shall
be ignored for the purpose of computing income chargeable to tax, if the original units were acquired
within 3 months prior to the record date fixed for receipt of additional units and sold within 9 months
from such record date. However, the loss so ignored shall be considered as cost of acquisition of such
additional units held on the date of sale by such person.

Wealth Tax
Units of Mutual Fund are not covered under the definition of ‘assets’ under section 2(ea) of the Wealth
Tax Act, 1957, and hence value of investment in units is completely exempt from Wealth Tax.

Gift Tax
The Gift Tax Act, 1958 has abolished the levy of Gift Tax in respect of gifts made on or after 1st
October 1998. Thus, gifts of units on or after 1st October, 1998 are exempt from Gift Tax. Further,
subject to certain exceptions, gifts from persons exceeding Rs.50,000/- are taxable as income in the
hands of donee pursuant to section 2(24)(xiv) of the Act read with section 56(2)(vi) of the Act.

Surcharge:
In case of Individuals, HUF-AOP-BOI, if income exceeds Rs 10 lakh, S.C.is @ 10%
of the Basic Tax Payable.
In case of other assesses like domestic companies, firms etc, if income exceeds
Rs 1crore, S.C is @10% of the Basic Tax payable.
In case of Foreign Company, S.C is @ 2.5% of the Basic Tax payable.
Matrix for the Set off of Various Capital Gains V/S Various Capital Losses:

Situation Regulation

STC Loss v/s LTC Gain Permitted

STC Loss v/s STC Gain Permitted

LTC Loss v/s LTC Gain Permitted

LTC Loss v/s STC Gain Not Permitted