A mutual fund is a professionally managed company that collects money from many investors and invests it in securities such as stocks, bonds and short-term debt, equity or bond funds and money market funds.
Mutual funds are a good investment for investors looking to diversify their portfolio. Instead of betting everything on one company or sector, a mutual fund invests in different stocks to try to minimize portfolio risk.
The term is typically used in the US, Canada and India, while similar structures around the world include the SICAV in Europe and the open-ended investment firm in the UK.
What are the tax rules and implications in mutual funds?
Mutual Fund investments are subject to capital gains tax. It is paid on the profit we make by redeeming/selling our mutual fund holdings (units). The gain is the difference in the net asset value (NAV) of the scheme at the date of sale and the date of purchase (sale price-purchase price). Capital gains tax is further classified depending on the holding period. For equity funds (funds with equity exposure > = 65%), the holding period of one year or more is considered long-term and subject to long-term capital gains tax (LTCG).
The LTCG tax of 10% is applicable to equity funds if the cumulative capital gain in a financial year exceeds INR 1 lakh. While doing financial planning, remember that your earnings remain tax-free up to 1 lakh INR. It is applicable to all investments made after 31 January 2018. Gains on holdings of less than one year are subject to 15% tax on short-term capital gains (STCG) in equity funds.
Long-term is defined as a holding period of 3 years or more in the case of non-equity funds (debt funds), and the LTCG tax of 20% is applicable to such holdings with indexation, i.e. the purchase price is adjusted upwards for inflation, while calculating capital gains. Profits on holdings of less than 3 years are subject to STCG tax, which is the highest income tax into which individuals fall.