Equity mutual funds are considered one of India’s most popular investment options. These funds help you grow wealth over the long term and come with a few tax benefits to help investors save on taxes. To get started with this mutual fund investment, it is essential to open a demat account to simplify the process of tracking investments in one place.
Let’s explore this blog to learn more about the key tax benefits that investors can avail while investing in equity mutual funds
Tax Saving ELSS Funds
ELSS or Equity Linked Savings Scheme funds allow investors to save income tax under the Section 80C deduction. One can invest up to ₹1.5 lakhs in ELSS funds in a financial year and claim tax deductions. As these funds have a lock-in period of 3 years, it helps investors create a disciplined approach towards investing. The key benefits include:
- Tax savings of up to ₹46,800 under Section 80C
- Short lock-in of 3 years compared to other tax-saving options
- Potential to earn higher inflation-adjusted returns over the long term
It is essential to have a proper asset allocation with ELSS funds as a part of one’s overall portfolio. Investors should continue with SIPs in these funds even after the lock-in period for wealth creation.
Taxation of Capital Gains
Equity funds attract different tax rates for short-term and long-term capital gains.
1. Short-Term Capital Gains Tax
Gains made if units are sold within 12 months are subject to a 15% short-term capital gains tax. This tax is calculated only on earned profits, not invested capital. To avoid this, investors can hold units for more than 12 months.
2. Long-Term Capital Gains Tax
Profits made if units are sold after 12 months are called long-term capital gains, and they enjoy beneficial tax rates. LTCG of up to Rs 1 lakh per year is fully tax-exempt. Any LTCG above this limit is taxed at 10% without indexation. The long-term holding period helps investors benefit from compounding.
3. Taxation of Dividends
Under the new tax regime, dividends from equity funds are subject to tax according to the investor’s income tax slab rates. This has made the growth option more tax-efficient for investors in higher tax brackets. However, retired investors with no other income sources can still consider the dividend option.
4. Securities Transaction Tax
A securities transaction tax (STT) of 0.001% is applied to equity funds during unit purchases and sales. The STT is added to the total transaction value and slightly reduces net gains. However, since the rate is very low, the STT does not significantly impact equity investing returns.
5. Tax Planning with SIPs
Investors can efficiently plan taxes on equity mutual funds if they opt for systematic investment plans (SIPs). Each SIP instalment purchase is considered a separate investment, and the 12-month long-term capital gains tax is calculated from the date of each instalment. Planning redemptions after each SIP instalment completes one year can help minimise taxes by taking advantage of long-term capital gains. Staggered redemption of SIP instalments helps optimise taxes.
6. Setting Off Capital Losses
Investors can use losses from selling equity funds to reduce taxes on gains. If you sell a fund for a loss before 1 year, you can use that loss to lower taxes on profits from selling funds you owned for less than or more than 1 year. Any leftover capital loss can be used over the next 8 years to lower taxes on future gains from selling funds. This helps optimise taxes for investors.
Conclusion
Equity mutual funds offer dual benefits of wealth creation and tax optimisation when appropriately planned. ELSS funds help save taxes, while the long-term capital gains tax rate benefits investors. Dividends and STT do not impact much. Avoiding short-term gains tax by staggered redemption of SIPs is key. Having a demat account is highly beneficial for streamlining your investments and managing equity fund holdings efficiently. Investors should consult their financial advisors to optimise equity fund taxation based on their portfolio and financial goals.
