Tax is a compulsory contribution or we can say financial charges which businessmen and investors pay to the state or central government as income tax. The rate of tax depends upon the annual income earned by an individual. An individual pays various types of taxes in direct or indirect ways. Direct taxes are income tax and indirect taxes are sales tax etc. Income tax is levied on the annual income of an individual, sales tax are levied on certain good and services. One has to abide by the law by paying the taxes regularly even on the income earned from mutual funds.

Now the question arises, what are the tax implications of investing in mutual funds? Well, let’s take an example, Aisha has her own business which is running successfully, she also has Fixed Deposits and some money invested in Mutual Funds. According to her, she will have to pay the  10% tax on the income she earned from interest but she is unsure about the tax implication on mutual funds. After filing the income tax returns, she was asked to pay more tax on the interest income earned and on the mutual fund which she had redeemed in the previous year.

An investor in mutual funds could earn the returns broadly in 2 forms-

1) Dividends

The dividends can be distributed to the investors only after the Dividend Distribution Tax(DDS) deducted at the source by mutual funds. No Dividend Distribution Tax will be deducted if the dividends are declared by the Equity Oriented Mutual Funds. DDT is applicable only on non-equity oriented mutual funds (Debt funds, Gold funds, etc).  The investors do not pay the tax under dividends earned from mutual funds.

There is no tax imposed on Equity Oriented Funds under Individual and HUF  investors and non-individual investors whereas there is 28.84% tax imposed under individual and HUF investors and 34.61% under non-individual investors. Dividends depend upon the face value of the mutual fund which is Rs 10/-  the investor would earn Rs 4 if the mutual fund declares a fund of 40%.

Net dividend for investors in mutual funds

The net Dividend after deducting DDT which is Rs 2.85 is tax-free in the hands of the investor.

2) Taxation on interest income

It is commonly misunderstood by people that if the income earned i.e. interest from bank deposits is less than Rs 10,000/- are exempted and if the interest income is more than Rs 10,000/- are taxed 10% which is deducted by banks before paying the interest. But the reality is that the income earned from deposits are fully taxable and are taxed at the marginal tax rate. This means that it is added to the total income while calculating the tax liability, it comes under “income from other sources”. The investor has to pay tax based on his income tax slab. So, an investor with an annual income of more than Rs 5 lakhs and less than Rs 10 lakhs are liable to pay a 10% tax. An investor with an annual income of more than Rs 10 lakhs is liable to pay a 30% tax, so the investor ends up paying a 30% tax on the interest income earned from mutual funds as well.

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