Income tax plays a vital role in helping the government build infrastructure and facilities the country needs as it develops. It is one of the highest contributors to the government’s wealth. As responsible citizens, we must pay taxes and pay them on time.
At the same time, a tax rebate means more earnings for us, and because of that, the government encourages several investment schemes with tax benefits.
Mutual funds are a beneficial investment scheme that is gaining some popularity. But do mutual funds come with any tax benefits? If yes, what are they, and does it apply to all the funds?
Mutual funds taxation
To understand the tax advantages of mutual funds investing, you have to first understand how mutual funds work and how they are taxed.
Mutual funds are a convenient way to invest in securities. Let us take the example of investing in stocks to understand this better.
To invest in stocks on your own, you first have to pick the stocks on your own. For that, you have to have a clear goal and have to pick stocks according to that goal.
Once you have made the pick, you have to time the market perfectly to get the best out of your investment. Timing is important to ensure you get the best out of your investment. For example, if you are investing during a time when there is superficial stock price growth, the correction that could follow may harm your chances.
Investing in mutual funds makes your job easier as there is a fund manager who takes care of most of the things said above.
Now, different mutual funds will have different portfolio choices. Mutual funds in themselves don’t have a standard taxation rule, but rather, they are taxed according to the portfolio choices. For instance, equity mutual funds are taxed similarly to equities.
Mutual funds are divided into equity and debt funds for ease of taxation. Both have different taxation rules for short-term and long-term investments – short-term capital gains and long-term capital gains taxes.
An investment below the period of one year is considered short-term in the case of equity mutual funds. The same is taxed at a flat 15%.
Short-term capital gains for the debt fund are according to the tax bracket the investor falls in. For instance, if your income falls in a bracket that is taxed at 20%, your short-term tax becomes the same.
One sure-shot way to save some taxes on your mutual fund investment is to invest for a longer period. That way, your earnings will be taxed according to long-term capital gains rules. This is beneficial in the case of both debt and mutual funds.
The only mutual fund scheme that comes with a tax saving component is an equity-linked savings scheme or ELSS. ELSS is an equity mutual fund with a lock-in period of three years. They come under Section 80c of the Income Tax Act 1961. This means your investment in ELSS that amounts to Rs.1.5 lakh can be tax-exempt.
ELSS is the only mutual fund that comes with a tax rebate. But investing in longer attracts lower taxes for other options as well. Plan your investments accordingly if possible to get tax benefits from mutual fund investments.