Reporting Mutual Fund Investments On Tax Returns

Mutual funds are a popular investment option for many, but it's important to understand how to declare them when filing your income tax return (ITR). The process can be complex, but by following a few key steps, you can ensure compliance with tax regulations and avoid penalties. Firstly, it's crucial to distinguish between the two types of income generated from mutual funds: capital gains and dividends. Capital gains are further categorised into short-term and long-term gains, depending on the holding period. Short-term capital gains arise when you sell units held for less than a certain period, typically ranging from 12 to 36 months across different types of funds. Long-term capital gains, on the other hand, result from holding units for a longer duration. These gains need to be reported in your ITR, with short-term gains specified under Income from Capital Gains and long-term gains reported under Schedule CG or Schedule 112A. It's important to note that long-term capital gains from equity-oriented funds are often tax-exempt up to a certain limit. Dividends received from mutual funds are generally taxable and should be disclosed as Income from Other Sources in your ITR. Additionally, interest income earned from mutual funds, particularly debt funds, should also be reported under Income from Other Sources. When filing your ITR, the form you select depends on the nature and amount of your income. If you have only salary income, income from one house property, and other sources (including interest income) up to a specified limit, you can opt for ITR-1. However, ITR-1 cannot accommodate capital gains from mutual funds. In such cases, you must use ITR-2, which covers various income types, including capital gains and dividends. ITR-3 is applicable if you have income from business or profession along with mutual fund earnings. To show your mutual fund investments in ITR-2 or ITR-3, provide details such as the purchase price, sale price, and holding period of the units. This information will be used to automatically calculate your capital gains tax liability. Remember, it's essential to understand the tax implications of your mutual fund investments and accurately report them in your ITR to stay compliant with tax regulations.

Dividends from mutual funds are taxable in the receiver's hands per the applicable slab rates

Previously, dividends from mutual funds were tax-free for investors as the companies paid dividend distribution tax (DDT) before distributing the dividends. However, with the introduction of the Finance Act, 2020, dividends from mutual funds are now taxed differently. Here's how it works:

• Debt Mutual Funds: The mutual fund house deducts DDT at the rate of 25% (plus applicable surcharge and cess) before distributing dividends to investors. Investors then need to declare these dividends as income when filing their income tax returns, and they are taxed based on their applicable slab rates.
• Equity Mutual Funds: While investors do not pay tax on dividends from equity mutual funds, the mutual fund house deducts DDT at a rate of 10% (plus applicable surcharge and cess) before distribution. This reduces the overall returns generated by the mutual fund scheme.

It's also worth noting that if the dividend income exceeds ₹5,000 in a financial year, the company or mutual fund is required to deduct Tax Deducted at Source (TDS) at a rate of 10%. This amount can be claimed as a tax credit when filing income tax returns.

Capital gains are taxed differently depending on whether they are short-term or long-term

Capital gains are profits made from selling assets such as stocks, real estate, cars, and boats. The capital gains tax is calculated by taking the total sale price of an asset and deducting the original cost. It's important to note that taxes are only due when the asset is sold, not during the holding period.

Capital gains taxes are divided into two groups: short-term and long-term, depending on how long the asset has been held. Here's how they differ:

Short-Term Capital Gains

Short-term capital gains tax is applied to profits from selling assets held for less than a year. These gains are taxed at the same rate as ordinary income, typically ranging from 10% to 37%. The holding period starts ticking from the day after acquiring the asset until the day it is sold.

Long-Term Capital Gains

Long-term capital gains tax is levied on assets held for more than a year. The tax rates for long-term capital gains are typically lower than those for short-term gains and ordinary income, ranging from 0% to 20%, depending on taxable income.

For example, if you buy $5,000 worth of stock in May and sell it in December of the same year for $5,500, you've made a short-term capital gain of $500. If your tax bracket is 22%, you'll pay the IRS $110, leaving you with a net gain of $390.

On the other hand, if you hold the stock until the following December and then sell it for a gain of $700, it becomes a long-term capital gain. If your total income is $50,000, you'll fall into the 15% tax bracket for long-term capital gains, paying $105 in taxes and retaining $595 in net profit.

In general, you'll pay less in taxes on long-term capital gains than on short-term gains. Therefore, holding onto an asset for more than a year can significantly reduce your tax liability.

The holding period and type of mutual fund affect the tax rate on capital gains

The holding period and type of mutual fund are key factors in determining the tax rate on capital gains.

Holding Period

The time between the date of purchase and sale of mutual fund units is known as the holding period. In India, income tax regulations incentivise longer holding periods, meaning that the longer you hold your investment, the lower your tax liability will be.

Type of Mutual Fund

Mutual funds are divided into various groups for tax purposes, including equity-oriented mutual funds and debt-oriented mutual funds.

Equity-Oriented Mutual Funds

These funds have at least 65% of their portfolio invested in Indian-listed equity shares. If the holding period of such a fund is less than one year, the returns are considered short-term capital gains and are taxed at 15%. If the holding period is more than one year, the returns are considered long-term capital gains and are taxed at 10%. There is also an exemption of up to Rs 1,00,000 on long-term capital gains, meaning tax at 10% is only calculated on gains above Rs 1,00,000. Examples of equity-oriented funds include tax saver funds, index funds, large and mid-cap funds, and flexi cap funds.

Non-Equity Oriented Mutual Funds

Non-equity mutual funds have less than 65% exposure to Indian-listed equity shares. If the holding period is less than three years, the returns are considered short-term capital gains and are taxed according to the individual's income tax slab. If the holding period exceeds three years, the returns are classified as long-term capital gains and are taxed at 20% with indexation benefits. Examples of non-equity mutual funds include gold funds, low-duration funds, and US opportunity funds.

Dividend income needs to be reported quarterly in the ITR form

Dividend income must be reported quarterly in the ITR form. This is because, since FY20-21, dividends distributed by a company are taxable in the hands of the investors. Prior to this, companies used to deduct dividend distribution tax (DDT) before declaring dividends to investors, meaning that dividend income was tax-free.

The quarterly breakdown of dividend income is to be reported in the ITR form, i.e. dividend income earned up to the 15th of June, 16th of June to 15th of September, 16th of September to 15th of December, 16th of December to 15th of March, and 16th of March to 31st of March.

This quarterly reporting is mandatory to avail of the relaxation of advance tax penalties on dividend income. Exemption from interest penalty under Section 234(C) for non-payment of advance tax is provided in the case of dividend income. The government has provided relaxation on penal interest on payment of advance tax as it is not possible to predict dividend income. Now, investors are liable to pay advance tax in the quarter in which the dividend is received.

The company is required to deduct tax deducted at source (TDS) at the rate of 10% in cases where the dividend paid or payable for the financial year is more than ₹5,000. This amount can be claimed back as a tax credit when filing your ITR.

It is expected that dividend income will be provided pre-filled to tax filers as the tax department has made it mandatory for companies to declare dividend information. However, if you receive pre-filled data in your ITR, you should check the information thoroughly.

In order to avoid rejection of your ITR form, you must report your dividend income breakup for the following periods:

• 1st of April to 15th of June
• 16th of June to 15th of September
• 16th of September to 15th of December
• 16th of December to 15th of March
• 16th of March to 31st of March

Mutual fund companies are required to deduct TDS at a rate of 10% on dividend income exceeding Rs 5,000

When it comes to dividend income from mutual funds, there have been some recent changes in how it is taxed. Previously, dividend distribution tax (DDT) was levied when the company distributed profits to the Asset Management Company (AMC), and then again when the AMC distributed the profits to unit holders. However, this led to double taxation, so DDT was abolished in the Budget for 2020. Now, dividend income is taxable in the hands of the receiver/investor.

With these changes, a new provision, Section 194K, was introduced. This requires mutual fund companies to deduct TDS (Tax Deducted at Source) when distributing dividends exceeding Rs 5,000 to unit holders. The rate of TDS is 10% if the unit holder has provided their PAN, and 20% if they have not. TDS is not required if the dividend income is up to Rs 5,000 in a financial year, or if the income is in the nature of capital gains.

If TDS has been deducted from your dividend income, you can claim a refund by filing an income tax return. You can do this by declaring your dividend income in your tax return and claiming any excess tax paid as a refund.

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