Mutual Funds are an investment instrument where funds are mustered from different sources to purchase securities. These sources can be financial institutions, companies, and individuals. Foreign investors can also invest in this market.
These funds generate income in the form of – dividends and capital gains.
The dividend is generated and disbursed periodically to the investor as long as the Mutual Funds belong to him/her.
Capital gains, on the other hand, are received when the investor decides the sell the fund. This gain arises out of the difference between the cost of acquisition and selling price. Prices of securities either appreciate or depreciate over a period. Depending on the case, an entity might make capital gains or losses.
These gains are bifurcated into two types – long-term capital gain and short-term capital gain on Mutual Funds.
In this article
Types of capital gains and Mutual Funds
The classification of gains originates from the holding period of the sold security. It represents the length of time for which an entity owned a particular fund. It varies across different mutual Funds for short-term and long-term capital gain.
The different kinds of Mutual Funds are –
Listed equity funds – This type of Mutual Funds are used to purchase shares and stocks of various companies listed under recognised stock exchanges such as NSE or BSE. These funds generate a higher rate of return; however, the risk factor is also high in these cases.
It is because returns heavily depend on cyclical market fluctuations. Equity funds qualify as short-term capital assets if they are redeemed or sold before 12 months or 1 year from the date of acquiring it. Any profit from such sale is considered as STCG on Mutual Funds.
Debt funds – These funds are invested towards purchasing of debt instruments from the stock market or otherwise. Incomes from these funds are steady as issuer companies are bound to disburse dividend periodically and entail a lower risk factor. However, the yield is lower compared to equity funds.
Gains from the sale of debt funds are considered short-term capital gain on Mutual Funds if the sale takes place within 36 months or 3 years of acquiring it. Examples of debt funds are bonds, 91-day treasury bills, debentures, etc.
Equity–oriented hybrid funds – These funds have a mix of both shares and debentures. However, in the case of equity-oriented hybrid funds, 65% or more of the investment goes toward shares and stocks. Therefore, the holding period for it to qualify as a short-term capital asset is 12 months.
These mutual Funds for short-term capital gains are a healthy investment option as individuals can exploit both the high-yield factor of equity funds and lower-risk factor of debt funds.
- Debt–oriented balanced funds – Like equity-oriented hybrid funds, these funds also composed of a mix of equity shares and debentures. However, unlike it, debt-oriented balanced funds comprise of 60% or more of debt instruments. Therefore, the maximum holding period for these funds is 36 months and short-term.
- Unlisted equity funds – These equity funds are directed towards the purchase of stocks or shares which are not listed in any recognised stock market. Gains from these funds are considered short-term capital gain in Mutual Funds if it is sold within 36 months of acquiring it.
The following table demonstrates the holding period for Mutual Funds
|Particulars||Short-term capital gain||Long-term capital gain|
|Listed equity funds||<12 months||>12 months|
|Debt funds||<36 months||>36 months|
|Equity-oriented hybrid funds||<12 months||>12 months|
|Debt-oriented balanced funds||<36 months||>36 months|
|Unlisted equity funds||<36 months||>36 months|
Short-Term Capital Gain on Mutual Funds: Tax Implications
Taxation on short-term capital gains is required to be paid from two ends – investor’s end and fund house’s end. Fund houses are organisations that act as fund managers for entities and have professionals with understanding in cyclical market fluctuations.
These organisations bear the responsibility to pay Dividend Distribution Tax on behalf of the investor.
The tax which is paid from the investor’s end follows the standard tax regime.
Taxation varies across all the different fund types and their holding period. In the case of short-term capital gain on Mutual Funds, the tax discipline maintained is as follows –
- Equity funds – Short-term capital gain on equity funds which are sold under-recognised stock exchanges are taxed according to Section 111A for 15%. These funds also incur Securities Transaction Tax (STT) which an investor pays from his end during the purchase or sale of funds. On the other hand, LTCG tax is charged at 10% without any indexation.
- Debt funds – In case of short-term capital gains on debt funds, the gain amount is added to the individual’s income during tax filing. The tax rate on short-term capital gain on Mutual Funds, therefore applicable, is the same as the slab rate to which total taxable income belongs.
Suppose Mr Anil, who is 45 years of age, earns Rs 25000 as a short-term capital gain for the year 2019. His total income for the year amounts to Rs 1200000.
The income amount attracts a 30% tax. Therefore, he is liable to pay a 30% tax on Rs 25000, which is Rs 7500.
- Equity-oriented hybrid funds – As the maximum share of these funds belongs to equity shares and stocks, they are taxed according to Section 111A for short-term capital gain on Mutual Funds for 15%.
- Debt-oriented balanced funds – These shares comprise mostly of debt instruments in the market; therefore, these funds do not attract Section 111A for taxation purposes. Short-term capital gain on Mutual Funds of this nature is added to an individual’s income and taxed as per the applicable slab rate.
- Balanced funds – Balanced funds comprise more than 65% of equity shares, stocks, equity-oriented schemes. Therefore, these funds attract a 15% tax as per Section 111A.
- Unlisted equity funds – STCG on Mutual Funds from this source is not compliant with Section 111A. An individual needs to post the gain amount from unlisted equity funds with his/her income to pay tax on it per the applicable tax rate. As these funds are not listed in any recognised stock exchange such as NSE or BSE, no Securities Transaction Tax is levied on these.
The following table illustrates the applicable tax rate of short-term capital gain on Mutual Funds
|Equity funds||15% u/s 111A|
|Debt funds||As per the individual’s slab rate (5%-30%)|
|Equity-oriented hybrid funds||15% u/s 111A|
|Debt-oriented balanced funds||As per the individual’s slab rate (5%-30%)|
|Balanced funds||15% u/s 111A|
|Unlisted equity funds||As per the individual’s slab rate (5%-30%)|
Short-term Capital Loss
In case a security is sold at a price lower than its cost of acquisition due to depreciation, it is considered as a short-term capital loss.
Short-term capital losses are set off against short-term capital gain on Mutual Funds, STCG on other investments, and long-term capital gains. In case the entire amount of short-term capital loss can’t be set off in a single year, it can be carried forward to the subsequent year. These losses can be carried forward for eight consecutive years.
Short-term capital gain on Mutual Funds is less tax efficient compared to long-term capital gains. Finance Ministry is also considering exempting tax on LTCG on securities after a security has been held for more than 3 years.