Mutual Funds (MF) are an important investment avenue for many investors. Equity MFs particularly have found favour with investors for their inflation-beating returns as well as being attractive investments as far as tax implications are concerned. Returns on mutual funds can be calculated in a number of ways; here are two common methods:
- Absolute Returns: The total change in the value of your mutual fund investment at the time of redemption is known as absolute returns. This method of computing returns does not take into consideration the time you have stayed invested in the fund. As an example, if you invest Rs. 1 lakh in a scheme, and after 3 years, the value rises to Rs. 1.3 lakhs, then by the formula:
Absolute Return = (Final investment Value-Initially invested Amount)/Initially Invested Amount x 100
Absolute Return = (1,30,000-1,00,000)/1,00,000 x 100 = 30%
- Annualised Returns: Annualised return implies return earned on your MF investment on an annual basis. In this method, the time you stay invested is taken into consideration while computing returns. Using the same parameters as in the example above, let us calculate annualised return:
Annualised Return = (Final Investment Value/Initial Investment Amount)^(1/Number of Years)-1
Annualised Return = [(1,30,000/1,00,000)^(1/3)-1]=9.14%
The importance of holding period
In MF investing, how long you hold your investment is important as holding period is a determinant of how the investment will be taxed:
- Long Term: If an equity-oriented fund is held for 12 months or longer, then this is regarded as Long term holding period. In case of debt funds, this period is 36 months. Long Term Capital Gains (LTCG) tax is applicable in this case.
- Short Term: If an equity-oriented fund is held for less than 12 months, then it is considered short term holding period. In case of debt funds, this period is less than 36 months. Short Term Capital Gains (STCG) tax is applicable in this case.
Understanding Mutual Fund Taxation
In case of equity-oriented funds, LTCG tax is not applied on gains up to Rs. 1 lakh (subject to conditions stipulated in the Income tax laws). For gains exceeding Rs 1 lakh, LTCG tax at 10.4% without indexation benefit is applied. Indexation refers to factoring in inflation into the purchase price of a fund. STCG is charged at 15.6% in case of equity-oriented MFs.
In the case of balanced fund that invest at least 65% of their assets in equities, the tax treatment is the same as equity funds. It should be noted that for Systematic Investment Plans (SIPs), each instalment of a SIP is considered an individual investment.
In case of debt funds, LTCG tax at 20.8% with indexation is applicable. In case the holding period is defined as short-term, then you will have to pay tax as per the income tax slab you fall under.
How mutual funds are taxed
| Type of Fund | ||
| Holding period >> | Less than 1 Year (short term capital gain) | More than 1 Year (long term capital gain) |
| Equity/Balanced fund (where investment in equity is at least 65%) | 15.6% tax | 10.4% tax for gains higher than Rs. 1 lakh |
| Type of Fund | ||
| Holding period >> | Less than 3 Years (short term capital gain) | More than 3 Years (long term capital gain) |
| Debt | Taxed as per your income tax slab | 20.8% tax with indexation benefit |
It is important to understand taxes on your investments in MFs so that you know what the real returns are on your investments. Real returns imply investment returns post tax. Investors can always use a calculator for mutual fund investment if they want to calculate returns easily.