Mutual funds are an efficient investment option to minimise tax liability and attain financial freedom. Investors often overlook the tax consequences while making investment decisions. For instance, an investor may get 5-6% interest from a fixed deposit scheme. However, the interest income is fully taxable, thus the effective post-tax return for an investor in the highest tax bracket will be tantamount to 4.2-4.9%, not even beating inflation in recent times. Mutual funds provide tax-friendly investment options to taxpayers. Mutual funds offer investors returns in the form of dividends and capital gains. Both dividends and capital gains are taxable in the hands of mutual funds investors. The capital gains arising from the sale of mutual funds depends on the holding period and type of mutual fund.
Equity Linked Savings Scheme
Investors can save taxes by investing in Equity Linked Savings Scheme (ELSS) Mutual Funds. ELSS are known to be great tax-saving instruments under section 80C of the Income Tax Act, 1961. ELSS mutual funds qualify for deduction from investors’ taxable income under Section 80C of the Income Tax Act 1961. The maximum investment amount eligible for tax deduction under Section 80C stands at Rs 1.5 lakhs. Investors in the highest tax bracket can therefore save up to Rs 46,350 in taxes (Rs 1.5 lakhs X 30.9% tax + cess) by investing in ELSS mutual funds. The overall ceiling of Rs1.5 lakhs includes all eligible items like employee provident fund (EPF) contribution, PPF, life insurance premiums, NSC and ELSS mutual funds etc.
ELSS has a lock-in period of three years which means that investors have to leave the money in notified funds for a minimum period of three years. There is no capping on maximum duration. ELSS offers the shortest lock-in period of three years when compared to other tax-saving instruments like PPF, NSC and post office savings deposits. ELSS is considered to be a very good option for investors who are willing to take moderate to high risks. Thus, mutual funds give unique and efficient tax savings solutions to investors while comparing with other asset classes over a tax saver app.
Tax on Equity Mutual Funds
Equity funds are those mutual funds whose portfolio’s equity exposure exceeds 65%. If an investor redeems equity mutual funds within a period of 12-months from the date of purchase, then short-term capital gains are attracted at a flat rate of 15%, irrespective of investors’ income tax bracket. Investors attract long-term capital gains on selling equity fund units after a holding period of one year or more. These capital gains of up to Rs 1 lakh a year are exempted from tax. Investing in equity funds and holding for more than 12 months is an excellent way to save tax and aim for wealth creation. Any long-term capital gains exceeding this limit attracts LTCG tax at the rate of 10% with no benefit of indexation provided.
Tax on Debt Funds
Debt funds are those mutual funds whose portfolio’s debt exposure exceeds 65%. If an investor redeems debt mutual funds within a period of three years from the date of purchase, then short term capital gains are attracted. These gains are added to investors’ taxable income and taxed at a normal income tax slab rate. This means that if you belong to a lower tax slab you will be taxed at a lower rate. Moreover, you can claim other tax deductions while paying tax on capital gains. Long-term capital gains are attracted when investors sell units of a debt fund after a holding period of three years. These gains are taxed at a flat rate of 20% after indexation plus applicable cess and surcharge on tax. With indexation, you can increase your initial investment value leading to a lower capital gain and lower tax liability.