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Tax saving ideas for MF investors

If you buy and hold an equity fund which is a debt MF for over three years, the tax will be nil

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In mutual funds, investing in stocks or bonds where fund managers earn capital gains, dividends and interest income, helps in saving income tax. Profit earned in the fund is either distributed as dividend to investors, who opt for it, or else become capital gain for investors who opt for growth option scheme of the fund. Debt funds generate part of their gain from interest income which can be similarly transformed into capital gains or dividend income for investors.

Equity linked savings schemes (ELSS) are simple diversified equity mutual fund schemes. The only difference is that, since they offer a tax break for the investor, they entail a lock-in period of three years. Normally, if the investor holds on to good stocks and good mutual funds over a longer period of time, you are likely to earn higher returns. Since ELSS has a compulsory lock-in period of three years, the investor is required to hold it for three years by default. Many investors do have the tendency to book profits in MFs on every rise in NAV. That tendency is not there in ELSS.

Apart from creating wealth over the long term, there is also an important tax benefit the investor gets when s/he invests in an ELSS. There is a tax exemption under Section 80C of the Income Tax Act which offers an exemption to the extent of Rs 150,000 per annum on ELSS investments. Of course, the ELSS gets clubbed with a variety of other items like insurance premiums, PF contribution, long term bank FDs, children's tuition fees etc. This tax break actually helps to improve the effective yield on the ELSS.

If you buy and hold an equity MF for over one year, there will be nil tax. For example, if you invest Rs 1 lakh in XYZ Fund and after one year, its value is Rs 1.3 lakh, there will be zero tax on capital appreciation of Rs 30,000. This is a very big advantage of equity Mfs.

Short Term Capital gain on Equity Mutual Funds: If you sell equity mutual fund before completion of 1 year you need to pay tax of 15% on capital gains. In the above example where gain was Rs 30000, if this was a short term capital gain, investor would have paid Rs 4500 as short term Capital Gain.

All other funds which will not qualify as equity fund will be part of debt MFs. If you buy and hold a debt MF for over three years, there will be nil tax. Any short-term capital gain that arises due to selling of debt fund before three years will be added to investor's income. Once it is added, it will be taxed according to tax slab of that individual.

There is no dividend distribution tax on equity mutual funds. The dividend received by investors is tax free. This is an added bonus for equity mutual fund investors. Even in case of debt MFs dividends received by investor are tax free in their hand or they don't need to show it as a taxable income. But there is dividend distribution tax paid by MFs to the tax department.

PRUDENT MOVES

  • If you buy and hold an equity fund which is a debt MF for over three years, the tax will be nil
     
  • There is no dividend distribution tax on equity MFs. However, dividend distribution tax is to be paid by MFs

The writer is chief investment officer, LIC Mutual Fund

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