Long Term Capital Gain Tax on Mutual Funds

Mutual Funds can be considered as a pool of investment which is used to purchase securities in the market. These investments are made by multiple entities in the market, such as individuals, companies, financial institutions, etc. Mutual Funds can be used to purchase securities of all kinds, such as equity funds, balanced funds, and debt funds.

In most cases, an individual’s investments are managed by a fund manager, however, if someone is an expert in market conditions and is aware of tentative market fluctuations they can choose to do the investments themselves, thus saving on fund manager’s fees.

Investment in Mutual Fund opens up multiple income opportunities in the form of dividends and capital gains. Dividends are disbursed periodically to investors on a pro-rata basis. Capital gains occur when an entity takes advantage of capital appreciation of security over time by selling or transferring it. Long-term capital gain tax on Mutual Funds and short-term capital gain tax as well varies across different investment options.

Understanding Details about Long-term Capital Gain Tax on Mutual Funds 

Individuals are taxed differently depending on the kind of funds they hold. The long-term capital gains tax implications across different Mutual Funds are –

  • Equity Funds

These Mutual Funds are used to purchase equity shares of different companies. There are two kinds of equity funds in the market – tax-saving equity funds and non-tax saving equity funds.

Equity-Linked Savings Scheme or ELSS is the tax-saving equity fund. In the case of ELSS, there is a lock-in period of 3 years before which an individual cannot sell or transfer his/her funds. Therefore these funds are bound to attract long-term capital gain on tax.

There is no such lock-in period in case of non-tax saving equity funds, and therefore they can attract both LTCG tax and STCG tax depending on the holding period. All kinds of equity funds trigger a tax of 10% above Rs. 1 Lakh without the benefit of indexation after 12 months. Investors can avail exemption up to the capital gain amount of Rs. 1 Lakh.

For example, Mr Anil invested Rs. 3 Lakh in an equity fund on 1.2.17 and sold the same on 31.3.2019 for Rs. 4.5 Lakh. His capital gain in that matter would be Rs. 1.5 Lakh. In that case, a 10% tax would be levied on Rs. 50,000 exceeding the Rs. 1 Lakh margin.

  • Equity-oriented Hybrid Funds

These Mutual Funds are used to purchase both equity funds and debt funds. However, in that composition, more than 65% of investment should be toward equity shares or equity-oriented shares. Therefore, these funds attract a similar long-term capital gain tax as equity funds.

  • Debt Funds

These Mutual Funds are used to purchase debt instruments from the market. LTCG tax rate on Mutual Funds is 20% after indexation. Indexation is done through the Cost Inflation Index (CII) which involves factoring in inflation in the cost of acquisition. It helps in lessening the capital gain amount.

The formula for calculating indexed cost of acquisition = (Actual cost of acquisition*Current year’s index)/ Base year’s index.

For example, Mr Bose invests Rs. 2 Lakh in debt funds on 30.4.15 and transfers the same on 1.2.19 for Rs. 3.5 Lakh. Cost Inflation Index in AY 2015-16 is 254, and in AY 2018-19 it is 280. The indexed cost of acquisition would be = (200000 x 280)/254 or Rs. 2,20,472 and long-term capital gain would be Rs. (350000 – 220472) or Rs. 1,29,528.

  • Debt-oriented Balanced Funds

In these kinds of funds, more than 60% of funds are reinvested towards debt instruments. These funds attract a tax rate of 20% after indexation.

  • Unlisted Equity Funds

Long-term capital gains on unlisted equity funds are taxed at 20% (surcharge and cess as applicable) with the benefit of indexation.

Table demonstrating long-term capital gain tax on Mutual Funds-

Particulars

Applicable Tax Rate

Equity funds

10% tax rate on the amount exceeding Rs. 1 Lakh without indexation

Equity-oriented hybrid funds

10% tax rate on the amount exceeding Rs. 1 Lakh without indexation

Debt funds and debt-oriented funds

20% tax rate with the benefit of indexation

Unlisted equity funds

20% tax rate with the benefit of indexation

Tax Implication on Systematic Investment Plan

The dynamics for long-term capital gain tax on Mutual Funds slightly different. In the case of SIP, every instalment is seen as a separate investment. Therefore, tax is levied separately on the gains from each instalment. The tax rate it triggers depends on the kind of fund invested in.

For instance, Mr C decides to begin SIP for Rs. 12000 quarterly in an equity fund on 1.2.18 for 12 months. He earns Rs. 2000 as capital gains from every SIP. After 12 months he decides to redeem the entire corpus of Rs 56000 (Rs. 48000 as the investment and Rs 8000 as gains).

However, short-term capital gain tax will be levied only on Rs. 6000 which are gains from later instalments and no long term capital gain tax on mutual funds will be levied from the first instalment as it is below Rs. 1 Lakh.

Tax Situation on Long-term Capital Gains

Before 2018, long-term capital gain tax on Mutual Funds for equity funds and equity-oriented hybrid funds did not exist under Section 10 (38).

However, after the introduction of Finance Bill 2018, the Section 10 (38) was lifted, and a parallel Section 112A was introduced which postulated a 10% tax rate on long-term capital gains above Rs. 1 Lakh and a grandfathering provision as well.

However, it posed difficulty for many entities, including foreign investors and discouraging investment sentiment in the stock market. Therefore, the Ministry of Finance is considering lifting long-term capital gains tax on Mutual Funds for funds which have been held for more than 3 years.

This measure might encourage investors to do not sway from their investment within the specified period.

Mutual Funds are considered one of the safest options for investments among market-linked financial instruments compared to other such instruments as it assures of periodical returns to a certain extent. Also, they offer higher returns compared to fixed-income instruments.

Primary advantages of Mutual Funds are they offer economies of scale, flexible investment options and higher liquidity compared to direct investments.

How to Calculate the Payable Tax against Long Term Capital Gains on Mutual Funds? 

To calculate the payable tax against LTCG on Mutual Funds, you are required to be accustomed to some specific terms as discussed below. 

  • Cost of Acquisition –value with which a seller has acquired the capital asset. 
  • Full Value of Consideration – consideration received or yet to be received by a seller as a result of a transfer of his capital asset. 

Calculation

For example, if Mr Das purchased shares in August 2016 at Rs. 50,000 and is sold in July 2018 at Rs. 3 Lakh (tenure more than 12 months) the income will be considered as a long-term capital gain. 

To calculate long term capital gain on Mutual Funds – 

  1. Full value of consideration: Rs. 3 Lakh
  2. Cost inflation index or CII for the mentioned year – 280 , hence the indexed cost of acquisition is Rs – 50,000 X (280/100) = Rs. 1,40,000
  3. The total taxable gain is Rs. 3 Lakh – Rs. 1,40,000 = Rs. 1,60,000 

Referring to the above table Mutual Funds LTCG above Rs. 1 Lakh is taxed at 10% = Rs. 1,60,000 X 10% = Rs. 16,000. 

Hence the tax payable amount on income will be Rs. 16,000 for the above mentioned example

Exemptions on Capital Gains

As discussed above, while calculating your LTCG in Mutual Funds, you are required to deduct the tax exempted amount. Given below is the section under which you can claim such exemptions.  

  • Section 10(38)

Under this section, long-term capital gains arising after the transfer of equity-oriented Mutual Funds or equity shares are free from taxes under the following circumstances. 

  1. The transfer should have been made on or after 1st October 2004. 
  2. It should be a long-term asset. 
  3. The sale transaction is required to be liable to the security transaction tax.
  • Section 54F

Under this section, you claim tax benefits on sales of an asset from long-term capital gain on mutual funds. 

These exemptions can be claimed under the circumstances of – 

  • You are required to purchase an asset one year prior or after two years from the date of sale.

  • You can also construct a property with your capital gain from sales. In such cases, the construction should be completed within three years from the date of the transaction. 

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