--
Understanding the tax implications is essential for investors seeking to grow their wealth through mutual fund investments. Long-Term Capital Gains (LTCG) is a crucial component of mutual fund taxation that plays a significant role in determining the returns on your investments. In this article, we’ll understand LTCG in mutual funds and its impact on investors.
A sale of any unit in mutual funds is subject to capital gains. However, the taxation depends on the holding period and type of scheme. LTCG refers to the profit earned on the sale of an asset or investment held for a specific duration. In mutual funds, LTCG occurs when an investor sells their mutual fund units after holding them for a particular period, as defined by tax regulations. The following table helps to understand the period of holding for the type of scheme and the taxability rate.
*Note: The LTCG rates for debt funds are applicable only on investments before 31 March 2023. From 1 April 2023, the capital gains from debt mutual funds will be taxable per the investor’s tax slab rate, irrespective of the holding period.
Equity funds primarily invest in stocks and equities. LTCG in equity mutual funds is subject to specific rules:
- Exemption Limit: Investors are exempt from LTCG tax on gains of up to INR 1 lakh in a financial year. You won’t incur any tax liability if your LTCG is below this limit.
- Tax Rate: Capital gains exceeding INR 1 lakh are taxed at a flat rate of 10%. A 4% Health and Education Cess is also applicable, resulting in an effective LTCG tax rate of 10.4%.
- Holding Period: More than 12 months
Understanding how LTCG is calculated can provide clarity on the tax liability. Let’s understand through an example: An investor holds equity mutual fund units for three years, and the following is the purchase & sale value.
Calculation:
Debt mutual funds primarily invest in fixed-income instruments like bonds and securities. The rules for LTCG taxation in debt mutual funds differ from those in equity funds:
- Holding Period: For LTCG classification in debt funds, the holding period is three years or more. If you sell your debt mutual fund units before three years, the gains are treated as short-term capital gains (STCG) and taxed according to your income tax slab.
- Tax Rate: LTCG in debt mutual funds is taxed at a rate of 20%, with indexation benefits.
- New Regime: From 1 April 2023, capital gains from debt mutual funds will be taxable as per the investor’s income tax slab rate. The above rates are applicable for investments before 31 March 2023.
Indexation is a significant advantage when calculating LTCG in debt mutual funds. It accounts for the impact of inflation on your investment, which reduces your taxable gains. The cost of acquisition is adjusted to reflect the increase in the general price level over time. The following is the formula to calculate the indexed cost of acquisition -Indexed cost of acquisition = {Cost of Inflation Index (CII) for the year of transfer (sale)/ CII for the year of purchase} * cost of acquisition
Let’s understand with an example: An investor holds debt mutual fund units for four years, and the following is the purchase & sale value.
A Systematic Investment Plan (SIP) is a simple method to save and invest money in mutual funds. SIPs help you invest a small amount regularly in mutual funds, and the frequency of investment can be chosen, like every week, month, or year.On every SIP purchase, you receive some mutual fund units. But the redemption of these units works on the first in, first out method (FIFO). For instance, if you invest in an equity fund through SIP for more than a year and take out your money after 13 months, the first units you get are considered long-term (because they are invested for more than 12 months). However, the units you receive later, from the second month onwards, are considered for short-term taxation (because holding period is less than 12 months). These units are taxable at a flat rate of 15%, irrespective of your income tax slab.
Understanding LTCG in mutual funds is crucial for investors to make informed decisions. Whether you’re investing in equity or debt mutual funds, the holding period and tax implications differ significantly. Also, exploring various tax saving options and staying updated with the latest tax regulations can help you optimise long-term capital gains and work towards long-term wealth creation. At Sigfyn, we consider all these factors before making buy/sell mutual fund recommendations.Happy Investing!
