Investors usually do not consider income tax consequences while making investment decisions. However, if the returns from an investment are fully taxable, which they are most often, then its effective tax-adjusted returns can come down by a few notches.
For example, if you’re getting an 8% return on your fixed deposit (FD) investment, then your effective post-tax return will be around 5.6% only (assuming that you’re falling in the highest income tax bracket of 30%).
This theory holds for market-linked investments such as mutual funds as well. Let’s understand the tax implications on mutual fund returns and how they can change if you opt for the new income tax regime.
How Are Mutual Fund Returns Taxed?
Mutual funds offer returns in two forms – dividends and capital gains. While dividends are paid by the companies when they have surplus cash, and they decide to share it with their investors, capital gains are the profits made by investors by purchasing mutual fund units and selling them at higher prices. Both dividends and capital gains are taxable in the hands of mutual fund investors.
As per the latest income tax rules, dividends received by investors are added to their annual taxable income and taxed as per the applicable income tax slab rate. However, capital gains are taxed according to the type of mutual fund and the period for which they were held by an investor.
In the case of equity-oriented mutual funds, capital gains are taxed at a flat rate of 15% if the funds are held for less than a year. If the funds are held for more than one year, capital gains up to Rs. 1 lakh in a year are tax-exempt. Any capital gains exceeding this limit are taxed at the rate of 10% without indexation.
Similarly, if debt mutual funds are held for less than three years, capital gains from them are added to the investor’s annual taxable income and taxed as per the applicable income tax slab rate. In case the funds are held for more than three years, capital gains from them are taxed at a flat rate of 20% after indexation.
Impact Of The New Tax Regime
The new income tax regime has a greater number of tax slabs and lower tax rates. If you opt for this regime, you won’t have to pay any tax if your annual taxable income does not exceed Rs. 5 lakhs. Additionally, the tax rates start from 5% and go up to 30%, with the highest tax rate applicable on annual income of Rs. 15 lakhs or more.
On the contrary, the old tax regime has slab rates of 5%, 20%, and 30%, with the highest tax rate applicable on annual income of Rs. 10 lakh or more.
So, as a taxpayer, you can enjoy greater tax benefits, and hence, your effective mutual fund returns can also increase. However, you won’t be able to claim any tax deductions if you opt for the new tax regime. Under the old tax regime, capital gains from ELSS investments were available for tax exemptions of up to Rs. 1.5 lakhs under section 80C of the Income Tax Act.
Conclusion
By opting for the new tax regime, you can reduce your applicable income tax rate, and subsequently, your effective post-tax returns on mutual funds would increase. To invest in mutual funds online, you can download the Tata Capital Moneyfy App on your smartphone. With this app, you can invest as lump sums and SIP, as per your choice and requirements.