Taxation of Mutual Funds & Shares

Mutual Funds and Stocks are the most popular investment vehicles in India for the following reasons:

Liquidity
Quick & easy investment process
Transparency
Diversification of funds
Cost-effective
Option to invest in smaller amounts and regular instalments
Can be tailored to suit your financial goals.

However, one should also understand the taxability of the same to get a holistic picture and make an informed decision. In this article, let us understand the tax intricacies in those investments and whether they are tax efficient.

I. Taxation of Mutual Funds:

Are you someone looking for guidance w.r.t investment in mutual funds? Then the following step by step process could help you understand the taxability of such investments:

Having a defined objective, period of investment, analysing your risk appetite and return requirement would help you choose the right funds to invest.

For tax purposes, the funds are categorised into two buckets – equity fund and debt fund. Hence it is important to earmark your funds as equity and debt.

Equity Fund	Debt Fund
Invests primarily in equities and equity related instruments In general, any fund which holds more than 65% in equity instruments	Invests primarily in debt and money market instruments

Investment in specific funds help you get deduction from the income liable to tax in the year of investment.
Equity

Equity Fund	Debt Fund
In case of ELSS funds, deduction u/s. 80C is available in the year of investment and saves up to INR 46,800/-.	No deduction

Refer our blog – Tax Saving Investments – A brief outlook dt. Aug 11, 2020

Dividend funds may yield you dividends from time to time. Such dividends have to be offered to tax in the year of receipt.

Taxability (Refer our blog – Taxability of dividends dt. Aug 07, 2020)

Pre-Budget 2020 – Dividends were exempt in the hands of the investor as the fund paid the DDT (Dividend Distribution Tax) (Section 10(35))

Post Budget 2020 – DDT abolished. Dividends are taxable at slab rates in the hands of the investor.

5a. Computation of holding period to understand whether the asset is short or long term–
Holding period is the period from the date of purchase till the date of redemption.

Equity Fund	Debt Fund
Short Term – Less than 12 months Long Term – More than 12 months	Short Term – Less than 36 months Long Term – More than 36 months

5b. Checking for indexation benefit w.r.t computation of purchase cost of the units–
Indexation refers to recalculating the purchase price, after adjusting for inflation index, as published by the Income Tax Authorities. Since the purchase price is adjusted for inflation, the capital gain gets reduced.
Such benefit is available only for debt funds.

5c. Rate of Taxation-

Equity Fund	Debt Fund
Short term asset - 15%. Long term asset – 10% if the capital gains exceed INR 1,00,000/- for the year. Additionally, security transaction tax (STT) would be deducted at the time of redemption.	Short term asset - Slab Rates. Long term asset - 20% after indexation.

Reporting of Investment	ELSS Funds – In the year investment	Sale of Units
Schedule AL – reporting mandatory in case where income exceeds INR 50 Lakhs	Schedule Chapter VI-A Schedule DI	Schedule CG Schedule 112A Schedule 115AD(1)(iii) proviso (For NR)

II. Taxation of Shares:

Shares would be the most profitable investment if invested wisely. At the same time, they are highly tricky and needs dedicated approach to gain profits. Taxation is one of the must know factors before making such highly technical investment. The following steps help you understand the same with ease.

Basis the objective of the investment and funds available, one must choose his stream of investment. Every investor has their own objective. There are long-term investors, intra-day traders (speculators), private equity investors, venture capitalists etc.

Listed Securities	Unlisted Securities
Shares that are traded through an exchange such as BSE, NSE	Shares not traded on an exchange but through the over the counter (OTC) market

Basis the objective of investment, shares would be either treated as ‘stock-in-trade’ or an ‘investment’.

If it is classified as stock-in-trade, any income from the same would be taxed under the head – PROFITS OR GAINS FROM BUSINESS OR PROFESSION and appropriate deduction would be available.
If it is classified as investment, gain from sale would be taxed as CAPITAL GAINS.

Listed Securities	Unlisted Securities
Taxpayers have now been offered a choice of how they want to treat such income. Once they choose, they must however continue the same method in subsequent years too, unless there is a major change in circumstances of the case. (As per Circular no. 6/2016 dated 29th February 2016)	Income arising from transfer of unlisted shares would be taxed under the head capital gain, irrespective of period of holding, with a view to avoid disputes / litigation and to maintain uniform approach. (As per Circular F.No.225/12/2016/ITA.II dated 02-05-2016)

Listed Securities

Unlisted Securities

Taxpayers have now been offered a choice of how they want to treat such income.
Once they choose, they must however continue the same method in subsequent years too, unless there is a major change in circumstances of the case.

(As per Circular no. 6/2016 dated 29th February 2016)

Income arising from transfer of unlisted shares would be taxed under the head capital gain, irrespective of period of holding, with a view to avoid disputes / litigation and to maintain uniform approach.

(As per Circular F.No.225/12/2016/ITA.II dated 02-05-2016)

Shares earn dividend from time to time basis the performance of the company. Such dividends must be offered to tax in the year of receipt.

Taxability (Refer our blog – Taxability of dividends dt. Aug 07, 2020)

Pre-Budget 2020 – Dividends were exempt in the hands of the investor as the fund paid the DDT (Dividend Distribution Tax) (Section 10(35))

Post Budget 2020 – DDT abolished. Dividends are taxable at slab rates in the hands of the investor.

4a. Computation of holding period to understand whether the asset is short or long term
Holding period is the period from the date of purchase till the date of sale.

Listed Securities	Unlisted Securities
Short Term – Less than 12 months Long Term – More than 12 months	Short Term – Less than 24 months Long Term – More than 24 months

4b. Checking for indexation benefit w.r.t computation of purchase cost of the units

Indexation refers to recalculating the purchase price, after adjusting for inflation index, as published by the Income Tax authorities. Since the purchase price is adjusted for inflation, the capital gain gets reduced.

Such benefit is available only for unlisted securities.

4c. Rate of Taxation

Listed Securities	Unlisted Securities
Short term asset - 15% Long term asset – 10% if the capital gains exceed INR 1,00,000/- for the year	Short term asset - As per slab rates Long term asset – 20% with indexation (NR – 10% without indexation) IPO Shares - Same as listed shares

Additionally, Security Transaction Tax (STT) is applicable at the time of sale of listed securities and on unlisted shares sold under an offer for sale to the public included in IPO and where such shares are subsequently listed in stock exchanges.

Reporting of Investment	Sale of Units
Schedule AL – reporting mandatory in case where income exceeds INR 50 Lakhs	Schedule CG Schedule 112A Schedule 115AD(1)(iii) proviso (For NR)

III. Whether MF and shares could be treated as effective investments from tax perspective?

The below table gives a comparison between the most common investments made by an individual giving a birds’ eye view on the tax efficiency of each investment which would help in better decision making.

Particulars	Immovable Asset		Gold	Current / Liquid Investment
Particulars	House Property	Land	Gold	Fixed Deposits	LIC / Insurance	MF	Shares
Deductions, if any at the time of investment	Section 80C - Repayment towards Principal of home loan Section 24(b) – Interest on home loan	Nil	Nil	Section 80C – Investment in Tax Savings FD Lock-in- 5 Years	Section 80C – Insurance premium paid	Section 80C- Investment in ELSS Funds Lock-in- 3 Years	Nil
Holding period for long term	More than 24 months	More than 24 months	More than 36 months	NA	NA	Equity – More than 12 months Debt – More than 36 months	Listed – More than 12 months Unlisted – More than 24 months
Tax rate on long term capital gains	20%	20%	20%	Interest Income – Slab rates	Maturity Proceeds - If premium paid exceeds 10% of the sum assured – Slab rates	Equity - 10% above INR 1,00,000 Debt – 20%	Listed – 10% above INR 1,00,000 Unlisted – 20%
Indexation available?	Yes	Yes	Yes	NA	NA	Equity – No Debt – Yes	Listed – No Unlisted – Yes
Tax rate on short term capital gains	Slab rates as applicable	Slab rates as applicable	Slab rates as applicable	NA	NA	Equity – 15% Debt – Slab rates	Listed – 15% Unlisted – Slab rates
Exemptions on capital gains	Section 54 - Capital Gain on Sale of Residential Property used for residential purpose Section 54GB - Transfer of Residential Property or plot of land and purchase of shares of eligible companies	Section 54 - Capital Gain on Sale of Urban Agricultural Land used for agriculture Section 54GB - Transfer of Residential Property or plot of land and purchase of shares of eligible companies	Section 54F - Capital Gain on sale of long-term capital asset other than Residential house property	NA	NA	Section 54F - Capital Gain on sale of long-term capital asset other than Residential house property	Section 54F - Capital Gain on sale of long-term capital asset other than Residential house property
Set off of losses	Only against house property income	Long term losses can be set off only against long term gains. However, short term losses can be set off against both long term and short term gains.		NA	NA	Long term losses can be set off only against long term gains. However, short term losses can be set off against both long term and short term gains.
Carry forward of losses	8 AYs	8 AYs		NA	NA	8 AYs

IV. Our Comments:

Most of the investments have the benefit of Section 80C deduction which has an upper limit of INR 1.5 Lakhs. Hence it would be a wise decision to spread the investments over the years to get optimal benefit of the same.
One may follow the following simple principle of investment every year:

The money accumulated vide investments in mutual funds, shares and fixed deposits could be used for investment in immovable and movable assets mentioned in the table in section IV above.

Hence, one has to have a purpose or objective before making any investment as every investment has its own unique features.
Mutual funds, if invested efficiently, could be one of the most beneficial investments. These investments could be tailored to meet one’s goals and requirements. While it could be stated that there is a higher risk w.r.t investment in shares, the returns are also higher.
From a tax perspective, one should opt for long term investment to reap major benefits. However, in case of equity MF and listed securities, one can try harvesting method* to avoid accumulation of gains over and above INR 1 Lakh.

(* Harvesting Method – Booking a portion of your profit immediately after one year and reinvesting the proceeds again in the same fund. This way the date of purchase of new units stands reset and shall be considered as a new investment.)