In today’s day and age, finding a way to make your money work for you so that you earn money in your sleep is paramount to a financially healthy future. The ever-increasing costs of living, inflation and diminishing savings have made a financially stable future a distant reality. Investments are the only way to help build a life that we desire. But like Lyndon B Johnson famously said – ‘NOTHING COMES FREE. NOT EVEN GOOD, ESPECIALLY NOT GOOD’ , investments come at a price – fees, charges and most importantly TAX. Even as a novice investor, countering these costs and earning returns that can help create wealth can be a daunting task, to say the least.
Investing in Mutual funds can offer three types of tax saving options to investors:
Different types of Mutual funds offer these tax benefits to investors.
Mutual funds offering Tax deduction – Equity Linked Savings Schemes (ELSS) also known as tax saving mutual funds are one of the most popular tax saving schemes in India. The principal amount invested in these funds is deducted from the taxable income of the investor, decreasing the tax liability. The deduction is subject to a maximum of ₹150,000 per annum. These schemes have a mandatory lock-in period of 3 years. As per Union Budget, 2018, all gains made on equity schemes after one year are liable to a tax of 10.4% (including indexation and cess).
Mutual funds offering tax exemption – This is primarily offered in long term holding of a domestic equity or equity oriented fund. For the purpose of tax calculation, ‘long term’ in case of equity funds is defined as a holding period of more than 12 months. All gains made after 12 months are termed as long term capital gains and are liable to a tax of 10.4% (including indexation and cess). It is important to note that only gains are exempt, the principal amount invested does not offer any tax benefits.
Mutual funds offering indexation benefits – Most of the other types of mutual funds – especially debt funds – offer indexation benefits while computing the tax liability. For the purpose of tax calculation, ‘long term’ in case of debt funds is defined as a holding period of more than 36 months. All gains made after 36 months are termed as ‘long term capital gains’ and are taxed at 20% post indexation. Here is an example to understand how indexation can benefit an investor:
Ram invests ₹20,000 in a debt fund in 2014 at an NAV of ₹20 and purchases 1000 units. After 36 months, he redeems his investment at an NAV of ₹40 (current value of the investment = ₹40,000). So, he stands to earn a ‘long term capital gain’ of ₹20,000. However, since he has held his investment for more than the stipulated 36 months, indexation comes into play.
The tax will thereby be computed on ₹15555.56 as against ₹20000, which were the gains pre-indexation.
Thus, investing in Mutual Funds can help in saving tax if the category of funds selected and the investment horizon opted for are in sync with the investment objective of the investor.