How To Calculate Tax On Mutual Fund Redemption

When you redeem the benefits of your mutual fund investments, you have to face tax obligations. These tax obligations depend on three factors. These factors are the type of your fund, the duration you held on to your fund, and the bracket of income tax you fall under. 

Knowing your Capital Gains

Calculating the Capital Gain is the easiest part of the process. It is the difference between the amount of money you had invested and the amount of money you receive when you redeem the funds. The formula for the same is given below: 

Capital Gain = Price when selling – Price when acquired

The tax obligations are decided based on the next factor, which is the type of fund. There are 2 major types of mutual funds. These are equity funds and debt funds. Which one you choose determines whether the profit you make is taxable or not. 

Tax on Equity Mutual Funds

The type of fund is decided by which investment avenue the money is invested in. Hence, if you have invested in a mutual fund that allocate atleast 65% of their assets into stocks, you will have invested in an equity fund. 

• Capital Gains in the Short Term (STCG):

  As the name suggests, this is the taxation that happen when you hold the investment for a small time. If you decide to redeem your investment within a year, the profit is considered as short-term gains and is taxed at 15% along with cess and surcharge.

• Capital Gains in the Long Term (LTCG):

  Similarly, if you redeem your investment after completing at least a year, the profits are deemed as long-term. In case of long-term profits, there is secondary condition for taxation. Only the profits above ₹1 lakh in a financial year are taxed at 10%. The first ₹1 lakh of profit is not taxed. However, long-term capital gains from equity funds do not receive indexation benefits.

Tax on Debt Fund Investments

Debt funds mainly invest in instruments that provide fixed income. The tax regulations are determined by the timing of your investment.

• For investments initiated on or after April 1, 2023:

  All profits are classified as short-term and included in your overall income, taxed according to your income tax bracket.

• For investments conducted prior to April 1, 2023:

  • STCG: If retained for under 36 months, taxed according to your tax bracket.
  • LTCG: When held for over 36 months, taxed at 20% incorporating indexation benefits.

Tax on Dividend Payments

Selecting the Dividend option means that the dividend you receive will be included in your income and taxed according to your tax bracket. If the annual dividend surpasses ₹5,000, the fund company withholds 10% TDS before distribution.

SIP Investments

Each installment in a Systematic Investment Plan (SIP) is treated as an individual investment. The First-In-First-Out (FIFO) approach is used during redemption, potentially resulting in a combination of short-term and long-term profits.

Imagine you cash in units from an equity fund:

• Redemption Amount: ₹5,00,000
• Buying Cost: ₹3,00,000
• Duration of Holding: 15 months (LTCG)
• Capital Appreciation: ₹2,00,000
• Tax-Free Limit: ₹1,00,000
• Taxable Profit: ₹1,00,000

Tax Due: 10% of ₹1,00,000 = ₹10,000 (additional cess and surcharge)

Summary

Comprehending the taxation of mutual funds aids in planning redemptions wisely. Maintaining your investment for the appropriate duration can reduce your tax liabilities and enhance after-tax returns, facilitating the attainment of your financial objectives more effectively