There’s a lot of buzz around general masses regarding LTCG rule brought in budget 2018-19. Let’s first try and understand what is long-term capital gains.
In common language, Long term capital gains is referred to as gains made from increase in price of shares/stocks as compared to the price of the shares at the beginning of the year, and long-term refers to investments made for more than one year.
The LTCG rule presented in Budget 2018-19: Government has proposed to impose tax of 10% on the gains made above ₹ 1 Lakhs. Initially, there was no tax imposed on the gains made form long term.
Hence, a havoc was created among the masses and soon a day after the announcement of the LTCG rule, the market became bearish, people started selling off their investments made in shares/mutual funds.
However, one boon given to older investors is that the LTCG tax is applicable on the gains made after 31st Jan,2018. The government has done this to ensure that investors who have committed money keeping in mind the easier tax regime are protected. This is referred to as the Grandfather clause
When LTCG tax was brought in, people were really tensed considering the fact that now if they get the returns of 15%, 10% tax will leave them in hand with only 5% of returns. But this is not true.
One needs to understand the basic difference between returns and gains obtained from mutual funds.
Returns or the income generated from the mutual funds refers to the dividends generated by the companies which need to be returned to the shareholders.
Gains in technical terms meaning capital gains refer to the positive difference between the end of the year price of the stock and the price of stock at the beginning of the year, but here in mutual funds it is slightly different. Consider the following example:
Let’s say XYZ Mutual Fund purchased 100,000 shares of a stock 20 years ago for Rs 1.
The fund sells the 100,000 shares today for Rs 50, which results in a long-term capital gain of Rs 49 per share. The fund must distribute the gains to current shareholders and the shareholders must report the gain on their personal tax return.
Therefore the taxes are applicable on the long-term capital gains as mentioned above. The total returns obtained by the investor in mutual funds include both capital gains distribution and dividend distribution.
For long-term capital gains made in the current financial year (2017-18), i.e. sale of funds up to March 31, 2018, there is no tax.
However, any sale made after April 1, 2018 will be liable to the new LTCG tax. One needs to segregate this LT capital gain into two parts:
a) Part I – is LTCG made upto Jan 31, 2018. This will be the NAV of the mutual fund on Jan 31, 2018, minus the cost of acquiring the units;
b) Part II – is LTCG made after Jan 31, 2018. This will be sale price NAV minus NAV of the scheme as on January 31, 2018.
As per the tax law, Part I will be exempt. It is the Part II, which will be assessed as LTCG for Tax.
Considering the above tax applications, one needs to think if the total returns obtained from the mutual funds is consistent and much higher than the LTCG gains above Rs. 1 Lakh then the investors should hold onto their investments, there is no worry about it to withdraw their investments so soon.
Disclaimer: views expressed here are of the author and do not reflect those of Groww.