Mutual funds, a universal topic have become a part of almost every body’s life. To frame simply mutual funds is the means of making investment but not the end result. It’s considered as a means just because, if you wish to invest in bonds you got to put your money in income funds, for government securities invest in gilt funds, for gold investment you got to buy gold fund. For someone interested in equities need to invest in equity-oriented fund and its combinations. There are monthly income plans (MIPs) for those wishing to employ maximum percent into bonds and less of corpus in equity. For equity and debt we have balanced funds, etc.

Considering the above mentioned examples we find mutual funds are of various types, balanced fund, sectoral funds, gilt funds, ELSS, income funds, MIPs, FMPs, open-ended funds, close-ended funds, etc. Close ended funds have a pre-defined maturity date however open –ended funds can be bought and sold anytime. FMPs have a fixed maturity period and invest in fixed income products like, bonds, government securities, money market instruments, etc. ELSS are equity linked savings schemes offering tax benefit under Sec. 80C (maximum Rs.1lakh), having a lock-in period of 3 years.   But for taxation purpose, Income Tax Act identifies only two types of funds 1) equity funds 2) non-equity funds. Let’s see how they both treated differently.

Equity fund: They are the funds investing more than 60% of your corpus in equity shares.

1. Long-term capital gains are free from taxes
2. Short -term capital gains are taxed at 15%
3. Dividends doesn’t attract any dividend distribution tax, applicable for both open and close ended funds

 Non-equity fund: For non-equity fund following is applicable

1. Long-term capital gains are taxed at 20%(with indexation) or 10%(without indexation)
2. Short term capital gains are added with other income of the investor and taxed as per tax rates applicable
3. Dividends attract a dividend distribution tax of 12.5%
4. No STT charges applicable

Mutual funds offer three different options which an investor can chose while investing in funds

1. Dividend option: Choosing dividend option offers dual benefit to the investor. One, the dividend is tax-free and second, you get a somewhat regular income through this, generally preferable in rising market.
2. Dividend reinvestment option: This option is much alike to growth option and choosing between the two depends on the circumstances. Choosing dividend reinvestment option proves to be a sound one when long-term capital gain tax will be imposed.
3. Growth option: Choosing growth option serves best when a dividend distribution tax is to be imposed in future.

To bring things together can say mutual fund is compilation of four basic things. They are risk, return, liquidity and tax efficiency. It’s a well-known fact that equity is a major component of any portfolio and mutual funds are your portfolio manager. Stay invested for a longer period of time rather than switching to different funds on continuous basis. The Most important thing is pick the one keeping in mind your cash flow requirements and needs.

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