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.
