FAQs: Tax benefits on mutual funds

Many people invest in mutual funds with a view to saving taxes. So what are the tax benefits investors get on investing in mutual funds? What tax rates are applicable? What are the benefits to overseas investors. Read on to find out. . .

What are the tax benefits investors get by investing in Mutual Funds?

Since, April 1, 2003, all dividends declared by debt-based mutual funds are tax-free in the hands of the investor. A dividend distribution tax of 12.5% (including surcharge) is be paid by the mutual fund on the dividends declared by the fund.

Investors in ELSS (equity-linked savings schemes) can avail rebate under Section 88 of the Income Tax Act, 1961 on investment up to Rs 10,000 subject to the various conditions laid down in the said Section.

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The actual amount of rebate depends on the level of income of the investor.

Is a capital gain on sale/transfer of units of mutual fund liable to tax? If yes, at what rate? Section 2(42A): Under Section 2(42A) of the Act, a unit of a mutual fund is treated as short-term capital asset if the same is held for less than 12 months. The units held for more than 12 months are treated as long-term capital asset.

Section 10(38): Under Section 10(38) of the Act, long-term capital gains arising from transfer of a unit of mutual fund is exempt from tax if the said transaction is undertaken after October 1, 2004 and the securities transaction tax is paid to the appropriate authority.

Section 111A: Under Section 111A of the Act, short-term capital gains arising from transfer of a unit of mutual fund is chargeable to tax @ 10% (plus applicable surcharge) if the said transaction is undertaken after October 1, 2004 and the securities transaction tax is paid.

However, such securities transaction tax will be allowed as rebate under Section 88E of the Act if the transaction constitutes business income.

Section 112: Under Section 112 of the Act, capital gains, not covered by the exemption under Section 10(38), chargeable on transfer of long-term capital assets are subject to following rates of tax:

• Resident Individual & HUF --- 20% plus surcharge.
• Partnership Firms & Indian Companies --- 20% plus surcharge.
• Foreign Companies --- 20% (no surcharge).

Capital gains will be computed after taking into account cost of acquisition as adjusted by Cost Inflation Index notified by the central government.

'Units' are included in the proviso to the sub-section (1) to Section 112 of the Act and hence unit holders can opt for being taxed at 10% (plus applicable surcharge) without the cost inflation index benefit or 20% (plus applicable surcharge) with the cost inflation index benefit whichever is beneficial.

Under Section 115AB of the Income Tax Act, 1961, long-term capital gains in respect of units purchased in foreign currency by an overseas financial organisation held for a period of more than 12 months will be chargeable at the rate of 10%. Such gains will be calculated without indexation of cost of acquisition. No surcharge is applicable for taxes under section 115AB, in respect of corporates.

What are the tax benefits for foreign investors?

Section 115E: Under Section 115E of the Act, capital gains chargeable on transfer of long-term capital assets of an Non-Resident Indians (NRIs) are subject to following rates of tax:

• Investment income: --- 20%
• Long term capital gains: --- 10%

Section 10(23D): Under provisions of Section 10(23D) of the Act, any income received by the Mutual Fund is exempt from tax.

Section 115R: Under Section 115R, the Income distributed to a unit holder of a Mutual Fund shall be charged to following rates of tax to be payable by the Mutual Fund.

• Amounts distributed to individual or HUF: 12.5%
• Amounts distributed to others: 20.0%

However, the above distribution tax will be exempted for open-ended Equity-Oriented Funds (funds investing more than 50% in equity or equity related instruments).

Are there any other tax benefits related to mutual funds?

Under Section 88, contributions made from taxable income in the specified investments qualifies for a tax rebate of 20% where gross total income is up to Rs 150,000 and 15% of the invested amount where gross total income is between Rs 150,000 and Rs 500,000, subject to a maximum aggregated ceiling of Rs 70,000.

For investment in infrastructure bonds and/or equity-linked saving schemes (ELSS) (not exceeding Rs 10,000/- under clause (23D) of Section 10), or eligible issue of equity shares or debentures the maximum qualifying investment limit for tax rebate is Rs 100,000. However, such tax rebate is not available in respect of tax on long-term capital gains as per Section 112 and short-term capital gains as per Section 111A of the Act.

Is there any wealth tax applicable to mutual fund investments?

No. Units held under the Scheme of the Fund are not treated as assets within the meaning of Section 2(EA) of the Wealth Tax Act, 1957 and are, therefore, not liable to Wealth Tax.

Is there any gift tax applicable to mutual funds investments?

No. Units of the mutual fund may be given as a gift and no gift tax will be payable either by the donor or the donee; since mutual funds do not fall within the purview of the Gift Tax Act.

How can I avoid payment of long-term capital gains on mutual fund investments?

The capital gain, which is not exempt from tax as explained above, can be invested in the specified asset mentioned below within 6 months of the sale.

Specified asset means any bond redeemable after 3 years:

• Issued on or after April 1, 2000 by NABARD (National Bank for Agriculture and Rural Development) or NHAI (National Highways Authority of India)
• Issued on or after April 1, 2001 by the Rural Electrification Corporation Ltd
• Issued on or after April 1, 2002 by the National Housing Bank or by the Small Industries Development Bank of India.

Such capital gains can also be invested in any residential house property in accordance with Section 54F of the Act and claim exemption from the capital gains.

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