What are the new changes in the Taxation of Mutual Funds? How Will My Mutual Funds be Taxed?

In this article, we will be discussing the taxation of mutual funds concerning the recent changes made by the Finance Ministry of the Government of India. So, let’s get started!

New Taxation Rules on Mutual Funds:

Debt Mutual Funds will be stripped of the long-term tax benefit if they invest less than 35% of their assets in equities. Such funds will fetch STCG tax. The GoI has proposed the formation of an amendment to the Finance Bill, 2023 in the parliament, which was passed in the Lok Sabha on Friday 24^th March 2023 with 64 official amendments. The changes in the taxation of mutual funds are categorized into 3 parts, which are as follows:

i) Equity-Based Allocation:

Equity-based allocation is those funds that invest over 65% of their funds into equity in a particular financial year.
Now as per the new taxation rules, there will be a short-term capital gain (STCG) of 15% on the equity-based funds if the individual withdraws the funds within 1 year of investment.
In the case of an individual holding equity-based funds for more than 1 year, then there will be a long-term capital gain (LTCG) of 10% on gains. But in the case of LTCG, if there is a gain of Rs. 1 Lakh, it will fetch no tax.
Taxation may vary based on the funds like Dynamic asset allocation funds, multi-asset funds, and balanced advantage funds.
Overall, there are no changes in the equity-based allocation fund as per the new taxation rule.

ii) Equity Allocation (35%-65%):

Equity allocation is the new allocation that has been introduced wherein the equity allocation in a particular fund is between 35% to 65%. It will be generally applicable to Balanced Hybrid Funds.
Here, if the individual holds the fund for less than 3 years, then it will be considered as STCG and a marginal tax rate will be applied, i.e., tax based on your slab rate.
If the individual holds the investment in this fund for more than 3 years, then it will be treated as LTCG, and flat 20% tax needs to be paid with an indexation benefit.
Indexation benefit means that individuals’ return on the fund will be adjusted with the inflation. For example: if an investor got a return of 8% during 3 years and there is CII inflation of 6%, then, he/she needs to pay tax on the gain from the fund on the adjusted return i.e. 2% (8%-6%).
Taxation may vary based on the funds like Dynamic asset allocation funds, multi-asset funds, and balanced advantage funds.

iii) Equity Allocation (0%-35%):

It will include those funds which have equity allocations of around 0% to 35%. Generally, it will include funds like debt funds, Fund of Funds, Gold ETFs, International FoF, and Conservative Hybrid Funds.
In these funds, the gain will be taxed on the marginal tax rate whether it is STCG or LTCG.

What Should Investors Do:

These changes in the taxation of mutual funds are important to understand for the investor as many times an individual plans investment from a taxation viewpoint. Hence, now since debt mutual funds or funds with allocation to equity of less than 35% have the same taxation with no benefits like indexation, etc. it becomes important for the investor to review their investment decision into these funds. Follow due diligence before making investment decisions.

Disclaimer: The information here is provided for reference purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent are commendation to buy or sell stocks or MF.