Tax Benefits of Investing in Mutual Funds

The mutual fund tax exemption is applicable when the total returns earned on the mutual fund investment are not more than INR 1 lakh and if you are redeeming the units after 1 year. This is applicable in the case of equity mutual funds.

This article covers: 

• Mutual fund tax benefit
• Mutual funds under 80C
• Best Tax Saving Mutual Funds (Data as of 19 April 2023)
• Tax Benefits of Investing in Mutual Funds- Quick Summary 
• Tax Benefits of Investing in Mutual Funds- FAQ

Mutual Fund Tax Benefit

Here is a table summarizing the tax benefits of investing in mutual funds:

• Tax Deductions under Section 80C

Section 80C of the Income Tax Act of 1961 allows investors to claim deductions up to Rs. 1.5 lakh. That is to say, if an investor invests in a mutual fund like Equity Linked Savings Schemes (ELSS) that qualify for tax deductions under Section 80C, they can claim a deduction up to Rs. 1.5 lakh from their taxable income. As a result, the investor’s tax bill goes down.

• Capital Gains Tax Benefits

Those who invest in mutual funds might realize capital gains by selling their holdings at a profit. Depending on how long an investor keeps their money in a mutual fund, they may owe either short-term or long-term capital gains tax.

If you have held the investment for less than 1 year, it is regarded as STCG or short-term capital gains and the interest earned on the investment will be taxed at 15%. On the other hand, if you held the investment for more than a year, it is regarded as LTCG or Long term capital gains and the interest earned on the investment will be taxed at 10% (only if the total interest earned is more than 1 lakh). 

• Tax on Dividend Income

From 1st April 2020, the dividend income tax is now fully taxable in the hands of investors and it is taxed according to the investor’s tax slabs. This income is added to the total income under the section “income from other sources”.

However, if the dividend in a financial year is more than ₹5,000 in a financial year, then it will attract a TDS (Tax Deducted at Source) at the rate of 10% under Section 194K of the Income Tax Act, 1961. The amount deducted as TDS by the AMC (Asset Management Company) will be deducted from the investor’s final tax liability in a financial year. 

Mutual Funds Under 80C

ELSS mutual funds come in the category of equity-oriented mutual funds as they invest 80% of the funds in stocks. For tax purposes, investors invest in ELSS mutual funds to get tax benefits of up to Rs. 1.5 lakhs under Section 80C of the Income Tax Act, 1961. They have a lock-in period of 3 years. Hence, you can’t redeem your investments from the ELSS fund until three years have passed. It’s important to consider your investment horizon before investing in an ELSS mutual fund. 

One thing you need to keep in mind is that investing in ELSS funds can be risky as they majorly invest in equity. So, make sure to do proper research about the fund objective, and fund manager’s experience and consider macroeconomic factors before investing. 

ELSS mutual funds compete with other tax saving instruments such as PPF (Public Provident Fund), NPS (National Pension Scheme), Tax Saving Fixed Deposits, National Saving Certificates, etc. 

Best Tax Saving Mutual Funds (Data as of 19 April 2023)

The best tax-saving mutual funds are given below in the table: 

Do you want to expand your knowledge about mutual funds? We’ve got a list of must-read blogs that will help you do just that. Just click on the articles to find out more.

Tax Benefits of Investing in Mutual Funds- Quick Summary 

• ELSS mutual funds provide tax benefits to investors under Section 80C of the Income Tax Act.
• Returns earned from ELSS mutual funds are tax-free if the investor redeems the units after one year and if the total returns are not more than INR 1 lakh.
• Capital gains tax is applicable on mutual fund investments depending on the holding period of the investor.
• As per the amendment in 2020, dividends received from mutual funds are taxed according to the investor’s income tax slabs. If the dividend income in a financial year is more than ₹5,000, then it will attract a TDS of 10%.  
• ELSS mutual funds are equity-oriented funds that invest 80% of their funds in stocks and have a lock-in period of three years. So, it is important to consider your risk appetite and investment horizon before investing. 
• Proper research about the fund objective, fund manager’s experience, and macroeconomic factors should be done before investing in ELSS mutual funds.
• Some of the best ELSS mutual funds are Quant Tax Plan Direct-Growth, ICICI Prudential Long Term Equity Fund (Tax Saving) Direct Plan-Growth, Motilal Oswal Long Term Equity Fund Direct-Growth, Canara Robeco Equity Tax Saver Direct- Growth, Motilal Oswal Long Term Equity Fund Direct-Growth, etc. 

Tax Benefits of Investing in Mutual Funds- FAQ