What is Long Term Capital Gain Tax on Mutual Funds

Investing in mutual funds can be a lucrative option to help grow your wealth. But you must understand the tax implications associated with your gains. And one such key aspect to be aware of is the long-term capital gain (LTCG) tax.

This blog is your go-to guide for all things related to LTCG tax on mutual funds, including the tax rates, applicable exemptions, and calculation methods. We'll break down what long-term capital gain tax is, how it varies across different mutual fund types, and share insights on calculating the payable tax.

Before diving into LTCG tax details, it's important to know how to select the best mutual fund for your portfolio. Getting this right is key to managing LTCG tax effectively.

What is Long Term Capital Gain Tax on Mutual Funds

You pay LTCG tax on profits you make from selling mutual funds that you hold for more than twelve months (equity funds) or thirty-six months (debt funds). For equity funds, gains up to ₹1 lakh are tax-free, but any gains above that are taxed at 10%. For debt funds, gains are taxed at 20% with indexation benefits.

By understanding these basics, you're well on your way to navigating the LTCG tax landscape and making more informed investment decisions.

Taxation on Different Types of Mutual Funds

Taxation on mutual funds varies depending on the kind of fund and the duration of your investment:

1. Equity Funds

Equity mutual funds primarily invest in company stocks. If you sell and profit over ₹1 lakh, you pay 10% tax on the amount exceeding ₹1 lakh. So, if your profit is ₹1.5 lakh, you'd pay tax on ₹50,000.

2. Equity-Oriented Hybrid Funds

These funds invest in a mix of stocks and bonds, but the equity portion is more than 65%. They follow the same tax rules as equity funds.

3. Debt Funds

Investing in bonds and other debt instruments, debt funds are taxed differently. If sold after three years, the gains are considered long-term and taxed at 20% with the benefit of indexation, which adjusts your purchase cost for inflation.

4. Debt-Oriented Balanced Funds

These funds have more debt than equity. Long-term gains, if held for more than three years, are taxed at 20% with indexation.

5. Unlisted Equity Funds

For investments in unlisted company stocks, LTCG tax is 20% with indexation, applicable if sold after two years.

Changes and Considerations in LTCG Tax on Mutual Funds

Before 2018, long-term investments in equity funds and equity-oriented hybrid funds were exempt from LTCG tax. However, the introduction of the Finance Bill 2018 brought about significant changes. LTCG tax on gains exceeding ₹1 lakh from such investments was set at 10%, even though a grandfathering provision was included to protect gains made before February 1, 2018.

These changes raised concerns, especially among foreign investors, and led to debates about the potential impact on investment sentiment. Recognizing these concerns, the Ministry of Finance is contemplating the removal of LTCG tax on mutual funds held for more than three years, aiming to encourage longer-term investments and provide stability to the market.

Calculating LTCG Tax on Mutual Funds

To determine the LTCG tax on mutual funds, you need to understand two key terms: Cost of Acquisition and Full Value of Consideration. The Cost of Acquisition is the amount you initially invested, while the Full Value of Consideration is the amount you receive when selling the investment.

Calculation

For example, if Gaurav purchased shares in September 2016 at ₹50,000 and sold in August 2018 at ₹3 lakh (tenure more than 12 months) the money earned will be considered as a long-term capital gain.

Let's calculate long-term capital gain on Mutual Funds:

Full Value of Consideration = ₹3,00,000

Cost inflation index or CII for the mentioned year = 280

Hence, the indexed cost of acquisition = ₹50,000 X (280/100) = ₹1,40,000

Total Taxable Gain: ₹3,00,000 - ₹1,40,000 = ₹1,60,000

Since the taxable gain exceeds ₹1 lakh, you will pay a 10% LTCG tax on ₹60,000, which amounts to ₹6,000.

Tax Exemptions on Long Term Capital Gains on Mutual Funds

Investing in mutual funds can come with tax liabilities, but there are exemptions available to reduce the burden of LTCG tax.

Section 10(38)

• Applicability: Previously applicable to equity funds and equity-oriented hybrid funds
• Conditions: Transaction should be made after October 1, 2004, involving a long-term asset, and subject to Securities Transaction Tax
• Current Status: This exemption has been withdrawn for transactions made after March 31, 2018

Section 54F

• Applicability: Applicable to all taxpayers earning LTCG from the sale of capital assets (other than residential house property), looking to reinvest in a residential house property
• Conditions: Purchase a new residential property one year before or two years after the sale or construct a new residential property within three years of the sale.

Key Takeaways

• LTCG Tax on Mutual Funds: Long Term Capital Gains tax is applied on profits made from the sale of mutual fund investments held for more than 12 months. The tax rate is 10% on gains exceeding ₹1 lakh for equity funds and 20% with indexation for debt funds.
• Tax Exemptions: Utilize sections like 54F of the Income Tax Act to claim exemptions on LTCG by reinvesting the gains in residential property.
• Calculation of LTCG: Understand key terms like Cost of Acquisition and Full Value of Consideration to accurately calculate the taxable amount.
• Different Mutual Fund Types: Equity funds, debt funds, and hybrid funds have different tax implications. Knowing these can help in tax planning.
• Recent Changes: Be aware of the changes in tax laws, such as the withdrawal of Section 10(38) post-March 2018, to stay compliant and make informed investment decisions.