Short Term Capital Gain – STCG Tax on Mutual Fund

The process of choosing the right mutual fund continues beyond focusing on the mutual fund's risks, returns and cost. What most investors need to remember is factoring in taxation. Ignoring which, many investors often overestimate investment returns and make wrong decisions.

Investors must remember that the actual returns earned from investments are earned after paying off taxes. And they differ based on the type of investment.

Before discussing short-term capital gains tax on Mutual Funds in detail and determining if dividend on mutual fund is taxable, let's quickly recap the fundamentals of investing.

Classification of earnings from Mutual Funds

Mutual funds collect capital from various investors and invest them in different assets. They then provide the returns on these investments to investors per prevailing market conditions. Depending on the asset class chosen, investors can earn two types of returns-

• Capital gains or the profits earned on the sale of an asset
• Dividends or the income earned when the underlying assets pay a regular interest

As an investor, your next question most likely is – are capital gains taxable? Is mutual fund dividend taxable? The answer to both these questions is yes.

Remember that mutual fund dividends are taxed as per the investor's income tax slab, whereas capital gains are taxed based on the fund scheme and the holding period. So, long-term and short-term capital gain mutual funds are taxed differently.

Here's all you need to know about the latter. Bonus: you learn if mutual fund dividend is taxable as well.

Short-term capital gains tax on Mutual Funds: What it means?

The returns from mutual fund investments having a short holding period between 12 -36 months (depending on the type of the fund) are termed short-term capital gains (STCG). Therefore, the short-term capital gains tax on mutual funds is the tax levied on these gains. Note that the STCG on mutual funds depends on the type of the fund. And as an investor, you can choose to invest in debt, hybrid, and other types of short-term capital gain mutual funds.

Below you will find a detailed analysis of STCG on mutual funds taxation for equity, debt, and hybrid funds. Let's get right into it.

When investors invest in debt funds, they put capital in securities like corporate bonds, commercial paper, treasury bills, and more. The owners of these securities pay back interest to the investors. So, the returns are in the form of dividends. These have a holding period of up to 36 months or less. So, the dividends earned are in the form of STCG on mutual funds.

If you've followed this blog, you know the answer to if mutual fund dividend is taxable is yes, it is. But how does income tax on mutual fund dividend work?

Equity Mutual Funds & their Taxability

Any mutual fund investing at least 65% of its assets in equity or equity-related instruments is considered an equity mutual fund. Equity mutual fund investments with a period of less than 36 months attract short-term capital gain tax and are taxed at a rate of 20% under section 111A of the Income Tax Act.

Debt Mutual Funds & their Taxability

Investors who invest in debt mutual funds for less than 36 months need to pay short-term capital gain tax on mutual funds, as per their income tax slab. They are not taxed under the 111 A charging section of the Income Tax Act.

For instance, say an investor earning Rs. 7 lakhs per annum who earned Rs. 40,000 from their short-term capital gain mutual fund. They wouldn't have to ask the question: is the mutual fund dividend taxable? The gains would be added to the taxable income, and the investor would need to pay Rs. 12,500 +20% of the (total income minus Rs. 500000).

As an investor, you might have gotten the answer to your question: is mutual Fund dividend taxable? So let's move on to understanding how hybrid mutual funds get taxed.

Hybrid Mutual Funds & their taxability

While debt mutual funds are short-term capital gain mutual funds with lower risk, they often do not offer high returns. Besides, as a first-time investor, you might ask, is mutual fund dividend taxable? Then you'd realise that you need to pay short-term capital gain tax on the mutual fund as per your income tax slab. But that's not the case with hybrid mutual funds.

Investors that want their mutual fund portfolio to have some diversity typically invest in hybrid funds or a mixture of debt and equity-oriented mutual funds. This way, they balance the risk and the returns. Keep in mind that hybrid funds can be either short-term or long-term investments. While short-term funds generate income, long-term hybrid funds are known to offer consistent returns over the term.

Investors can put their money into different types of hybrid funds like equity-oriented hybrid funds, balanced funds or debt-oriented hybrid funds. Unlike debt funds, both short-term and long-term hybrid funds offer STCG on mutual funds. The short-term capital gain tax on mutual funds in either of these cases then depends on the holding period of the funds. Let's take a look at the short-term capital gain tax on the mutual fund for hybrid funds.

• Hybrid mutual funds wherein 65% or more of mutual fund assets are invested in equity instruments are liable for taxation. Such equity-oriented mutual funds taxation is at 15% for funds with a holding period of 12 months or less.
• Hybrid debt-oriented balanced funds wherein 60% of the fund's asset allocation are in debt instruments are also liable for taxation. If the holding period for the funds is under 36 months, unlike equity-oriented mutual funds taxation, the returns are taxed as per the investor's income tax slab. So, if you're wondering: is the mutual fund dividend taxable? Yes, it is. This is even specified under the specific charging section of the Income Tax Act.

Taxation of STCG on SIP

SIP is an attractive investment method for mutual funds which allows investors to invest a small amount regularly towards a mutual fund scheme of their choice.

For taxation purposes, each SIP instalment is treated as a separate purchase. When you invest in mutual funds through SIP, you buy a certain number of fund units with every SIP payment. So, the redemption of mutual funds follows a first-in-first-out principle.

For instance, you purchase equity mutual funds through SIP for one year but then decide to redeem the funds after 13 months. Since the units purchased in the first month have been held for over a year, they will be treated as long-term gains on redemption.

However, for mutual fund units from the second month onwards, you will realise short-term capital gains, which will carry a STCG tax at a rate of 20%, irrespective of your income tax slab.

Other Tax on Short-term Capital Gains on Mutual Funds

Apart from the short-term capital gain mutual funds discussed above, many other funds are liable to additional taxes. For instance, equity funds are liable for taxation under the respective charging section of Income Tax Act. Often collected at the source, this equity-oriented mutual funds taxation is for securities listed and sold in stock agencies. A 0.001% Securities and Transaction Tax is levied on investors for every sale listed under a stock exchange.

Now you are equipped with information about short-term capital gains tax on mutual funds and have answers to the questions: is your mutual fund dividend taxable, and what is the income tax on mutual fund dividend? So you should be able to pay taxes on time and estimate your actual returns well in advance. If you need more information about mutual fund options or short-term capital gain tax on mutual funds, visit the Moneyfy website or download the tata capital's investment app from the playstore.

FAQs

How is short-term capital gains tax calculated for mutual funds?

The returns from the sale of mutual fund units holding 12 to 36 months are considered short-term capital gains and are taxed at 20%.

Is short-term capital gain below 1 lakh taxable?

Short-term capital gains (STCG) on mutual funds are taxable at 20% regardless of the amount. Unlike long-term capital gains, there is no exemption limit for STCG.

Do mutual funds pay short-term capital gains?

Redemption of mutual funds with a holding period of less than 36 months is considered short-term capital gains.

Which STCG is taxed at 30%?

STCG on debt mutual funds are taxed per the investor's tax slab rate. So, if an investor is in the highest tax bracket, the gains will be taxed at 30%.