Any reduction in tax outflow is a plus for returns on investment, especially in the case of equity mutual fund returns. Equity mutual funds remain one of the best ways to generate higher returns on investment, but the absence of tax planning can easily erode the gains generated. Returns on equity mutual funds are no longer exempted from tax as they were in the past.
The capital gains from equity mutual fund investments are subject to capital gains tax. This could be either short-term or long-term capital gains as per the holding period of investment. The capital gains from an investment held up to one year fall under the short-term capital gains category or STCG. STCG is taxed as per the investor’s income tax bracket.
With the introduction of long-term capital gains tax (LTCG) on equity mutual funds, investors developed a few concerns. Many investors are now faced with complex decision-making around the timing of withdrawal from equity mutual fund investments. Are equity mutual funds still worth it? Will LTCG curb the returns from equity funds? Here are the answers to every equity mutual fund investor’s questions regarding the impact of LTCG.
Table of Contents hide
1 What are capital gains?
2 Why is equity mutual fund investment a good choice despite LTCG?
3 LTCG on Equity linked Savings Scheme
4 LTCG on Mutual Funds
5 How to save LTCG on equity-oriented funds
6 Conclusion
7 FAQs
What are capital gains?
Capital gains result from the increase in the value of mutual fund units. It is realised when the capital asset or mutual fund units are sold. If you invest in and hold an equity mutual fund investment for more than a year and then sell it, the capital gains (if generated) will be categorised as long-term capital gains.
Understanding changes in long-term capital gains on equity-oriented funds
As part of the Union Budget 2018 announcement, the long-term capital gains (LTCG) on the sale of listed equity shares were made taxable with effect from 01 April 2018.
Only the short-term capital gains were taxed at a rate of 15%. The objective behind letting LTCG tax-free was to increase the participation of investors in equity markets in India. Owing to the exemption, the investors had started perceiving equities as a favourable investment vehicle. However, LTCG on equity-oriented funds is subject to taxation after the Union Budget 2018.
The Long-term capital gains (LTCG) over Rs 1 lakh on listed equity shares and equity mutual funds per financial year is taxable at the rate of 10% without the benefit of indexation.
Why is equity mutual fund investment a good choice despite LTCG?
Here are some of the top reasons why, despite the introduction of LTCG, equity mutual fund investments remain an ideal choice for investors looking to generate positive long-term returns:
- Insignificant impact of LTCG tax
The Union Budget 2018 announced LTCG tax to be paid on gains from equity investments made after March 31, 2018. If you have invested in an equity mutual fund and sell it within one year of investment, LTCG tax is applicable to the gains.
- This tax is applicable for LTCG above Rs. 1 lakh in a financial year. For example, if an investor got long-term gains of Rs. 1.2 lakhs in a year, LTCG tax will be applicable only on Rs. 20,000 i.e. Rs. 1.2 lakhs–Rs. 1 lakh. Thus, the tax payable will be Rs. 2,000, calculated @ 10% on the gains.
- Since equity mutual funds should be viewed from a long-term investment perspective, investors can save on LTCG tax by staying invested for a longer time frame. This can help generate sufficient gains to potentially negate the impact of tax to be paid.
- Good long-term investment vehicle
Despite the LTCG, equity mutual funds are a good investment instrument for long-term wealth creation. This is because equity funds can have the potential to generate better returns than other bank savings and fixed-income investment schemes. Fund managers of equity funds generally churn their portfolios from time to time and the resulting profits that are booked are either distributed to investors as dividends or reinvested in for generating future profits through compounding.
- High Liquidity
Equity mutual fund investments can easily buy or sell units in a fund scheme depending on its performance. An investor can redeem the units of an equity fund at any time on any business day at the prevailing NAV. This provides liquidity to investors. However, for ELSS funds, an investor is not allowed to liquidate his/her investment unless the lock-in period of 3 years is complete.
As investors adjust to the LTCG tax regime, they can continue to yield returns and benefit from liquidity of equity mutual fund investments.
LTCG on Equity linked Savings Scheme
Equity Linked Savings Scheme (ELSS) investments are subject to Long Term Capital Gains (LTCG) tax if they are held for more than 1 year. The LTCG on ELSS is calculated at the rate of 10% if the gains are above Rs. 1 lakh in a financial year.
If an investor sells ELSS investments before holding them for a year, it will be considered a Short Term Capital Gain (STCG), and the gains will be added to the investor’s taxable income and taxed according to their income tax slab rate.
ELSS has a lock-in period of 3 years, after which investors can continue their investment in the scheme without any capping. Any redemption after the lock-in period will be subject to LTCG tax.Investors can also claim a tax deduction of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act for investments made in ELSS schemes. This can help reduce their tax liability.
LTCG on Mutual Funds
Long Term Capital Gains (LTCG) tax on mutual funds applies to any gains made on the sale of mutual fund units held for more than 1 year. The LTCG tax rate on mutual funds is currently 10% for gains above Rs. 1 lakh in a financial year. Mutual funds held for less than a year are subject to Short Term Capital Gains (STCG) tax, which is added to the investor’s taxable income and taxed according to their income tax slab rate.
How to save LTCG on equity-oriented funds
Capital gains generated from equity fund investments can be offset against any capital losses incurred during the sale of these funds. However, it is important to note that a long-term capital loss can only be set off against long-term capital gains.
In case an investor is unable to adjust capital losses in the same financial year, they can carry it forward for the consecutive eight years. The losses can be offset against capital gains in the following years.
Conclusion
The impact of LTCG can be reduced depending upon the manner in which an equity mutual fund investment is made and units are redeemed. Long-term capital gains on equity funds should not be the deterrent for an investor looking to invest in equity funds. These can still be used for wealth creation as they are professionally managed by experienced fund managers.
FAQs
- Is LTCG tax applicable on all mutual funds?
Yes, LTCG is applicable on all kinds of mutual funds, whether equity, debt or hybrid funds.
- How can we avoid LTCG tax on mutual funds in India?
Investors can save LTCG tax by using tax harvesting. Under this method, one can book long-term gains from equity funds up to Rs. 1 lakh and reinvest the amount. The reinvestment value is the new cost of acquisition. This process can help investors to get Rs. 1 lakh exemption under LTCG.
- How to invest in equity mutual funds?
An investor can download the Fisdom app to begin investing in mutual funds. The app lists various mutual fund categories for different investment time horizons. It also provides information on fund performance for better decision making.
- Is mutual fund income taxable?
Yes, mutual fund returns are subject to long term and short-term capital gains tax, depending on the investment time period and amount of returns generated.
- At what limit LTCG is tax free?
Returns from equity mutual funds under Rs. 1 lakh per financial year are exempt from long-term capital gains tax. Any returns above this amount are taxable at the rate of 10% without the benefit of indexation.
