Q. I have been investing in mutual funds for the last 2 years. Are there any special funds where I can invest to avail tax benefits?
Mutual funds help you achieve your financial goals and are also tax-efficient instruments. However, before investing in mutual funds, you should clearly understand how your returns are being taxed. This will help you plan the investments to save on tax.
Factors which determine the taxation on mutual funds
Fund type: Debt-oriented mutual funds and equity-oriented funds are taxed differently.
Dividend: Dividend is the profit distributed among investors by the mutual fund houses.
Capital gains: When investors sell their investments at a price higher than the purchase price, the profit is known as capital gain.
Holding period: As per the income-tax regulations in India, if you hold your investment for a longer period, you are liable to pay a lower tax amount.
Calculate capital gain
Fund | Holding period | Capital gains | ||
Short | Long | Short-term | Long-term | |
Equity Funds | Less than1 year | More than1 year | 15% + cess + surcharge | Up to ₹1 lakh a year is tax-exempt. Gains above ₹1 lakh taxed at 10% + cess + surcharge |
Debt Funds | Less than3 years | More than3 years | Taxed at the investor’s income-tax slab rate | 20% + cess + surcharge |
Hybrid equity-oriented | Less than1 year | More than1 year | 15% + cess + surcharge | Up to ₹1 lakh a year is tax-exempt. Gains above ₹1 lakh taxed at 10% + cess + surcharge |
Hybrid debt-oriented | Less than3 years | More than3 years | Taxed at the investor’s income-tax slab rate | 20% + cess + surcharge |
Advantage ELSS
Unlike fixed deposits, where the interest gets added to the taxable income, mutual funds are tax friendlier. When you invest in mutual funds, you get the double benefit of experts managing your money and tax-efficient returns. Mutual funds offer a wide range of options. Equity-linked savings schemes (ELSS) are one such investment option.
When you invest in ELSS, you get tax exemption on the invested amount up to a maximum of ₹1.5 Lakhs under Section 80C of the Income-tax Act, 1961. Not only that, but it also gives you an opportunity to build wealth thanks to its lock-in period of 3 years.
Given that ELSS invests in equity, this time frame provides a higher chance of creating more wealth. ELSS is the only product under 80C that has this short a lock-in period compared to PPF (15 years), FD (5 years) and NSC (5 years).
Long-term capital gain from ELSS is tax-free up to ₹1 lakh per year and the gain above this is taxed at 10%.
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