Income Tax Saving Tips for Mutual Fund Gains 

In the last few years, the financial market has seen a complete transformation. Investment used to be a complex subject, tackled only by seasoned traders and financial institutions. Today, anyone with access to the internet can grow their money quickly and easily through stocks, mutual funds, debt instruments, etc., according to their risk appetites.

Among all the options available, mutual funds promise high returns with comparatively lower risk. However, you should always remember that profits earned through investments are liable to be taxed.

In India, the profits you book from your mutual funds are taxed under the Capital Gains section of your Income Tax Return (ITR). In this article, we will talk about tax-saving tricks to help you save considerably on your capital gains.

Types of Taxes on Mutual Fund Gains

Capital gains are the profit or gain arising from the sale of a capital asset. When your mutual fund reaches its expiry date, you usually receive a return higher than your initial investment. Your capital gains are the difference between your initial investment and the return you receive. There are two types of capital gains- short-term capital gains and long-term capital gains. The tax rules are different for these gains. There is a tax saving trick for long-term gains.

Read More About Tax on Mutual Funds

Short-Term Capital Gains Tax

If you buy a mutual fund and decide to sell it before one year has passed, you will need to pay a short-term capital gains tax of 15% plus an additional 4% health and education cess on the tax, irrespective of your income tax bracket.

For example, say you invested ₹20,000 in a mutual fund in September 2022 and needed to exit the fund in January 2023 at a return of ₹23,000. Your capital gain is ₹3,000.

The tax you will need to pay will be:

15% of ₹3000 + (4% of Tax)

₹450 + 4% of ₹450

450 + 18

₹468

Mutual fund investors don’t usually sell their holdings in the short term because the idea is to let your money grow for a period of 5 to 10 years, or the duration of the fund’s term. The tax-saving tip we are about to provide will not be plausible here because there is no exemption.

Long-Term Capital Gains Tax

If you hold a mutual fund for a period longer than one year, you become liable to pay a long-term capital gains tax of 10% if your profits are greater than ₹1 lakh. A benefit for mutual fund investors is that a profit up to ₹1 lakh is exempt from this tax.

Say you invested ₹30,000 in a mutual fund in 2020, which expires in 2025, bringing you a return of ₹1,20,000. Your capital gain of ₹90,000 is exempt from tax. However, if your mutual fund brought you a return of ₹2,40,000, your capital gains become ₹2,10,000.

Of this amount, ₹1 lakh is exempt, so you will need to pay 10% of the remaining ₹1,10,000 as a long-term capital gains tax. That means your tax liability will be ₹11,000 in the year when the profit is booked. In this exemption lies a tax-saving trick for mutual fund investors.

Tax Saving Trick For Mutual Fund

You get the exemption of ₹1,00,000 in every financial year. So, this tax-saving trick for mutual fund investment works on a simple principle of splitting the amount you redeem over two financial years instead of booking it all at once. In the example we saw above, your capital gains of ₹2,10,000 were booked all at once, making your tax liability ₹11,000.

However, if you choose to redeem ₹1,05,000 in February 2025 and the remaining amount in April 2025, your liability will reduce:

FY2024-2025 Tax Return

Capital Gains: ₹1,05,000

Exempt: ₹1,00,000

Taxable Amount: ₹5,000

10% Tax: ₹500

FY2025-2026 Tax Return

Capital Gains: ₹1,05,000

Exempt: ₹1,00,000

Taxable Amount: ₹5,000

10% Tax: ₹500

By splitting your redemption over two financial years, you availed the ₹1 lakh exemption twice, thereby reducing your tax liability from a total of ₹11,000 to a total of ₹1,000. This tax-saving trick will be even more beneficial by limiting the withdrawn capital gain under the exempted limit for every financial year.

Conclusion

Today, we all know how to invest our money smartly and efficiently to maximise our returns. The next step of our investment journey is to protect our funds by understanding how to take advantage of the benefits provided to us under the tax code with tax-saving tricks.

The more we learn about tax-saving tips, the greater the wealth we can create to safeguard our futures and create a solid financial foundation for the next generation. So, keep exploring the vast knowledge base at Angel One for more tax-saving tricks and contact us any time if you have an investment-related query.