Long-Term Capital Gain Tax on Mutual Funds in India | Angel One (2024)

Mutual funds are one of the popular investment options that can help your wealth grow and achieve financial goals. They are also viewed as a tax-efficient investment option. The profits from mutual funds are considered capital gains. In this article, learn in detail about long-term capital gains tax on mutual funds.

What Are Capital Gains?

Capital gains refer to the profit earned from an investment such as stocks, real estate, mutual funds, etc. There are two types of capital gains.

  • Short-Term Capital Gains (STCG): These are gains from investments that were held for one year or less than that.
  • Long-Term Capital Gains (LTCG): These are gains from investments that were held for more than one year. Long-term capital gains are usually taxed at a lower tax rate than short-term gains.

Long-Term Capital Gain Tax on Mutual Funds

You will have to bear taxes on mutual funds that you hold for more than a year, and the capital gains are above ₹1 lakh. The LTCG tax rate on mutual funds is 10% with no indexation benefit.

Note that taxes on mutual funds are levied only when you sell the scheme units.

Previously, before 2018, as per Section 10 (38), mutual funds capital gains were taxed 10% if the gains were more than ₹1 lakh. Later, with Finance Bill 2018, Section 10 (38) was eliminated.

Indexation benefit: It allows investors to adjust the purchase price of an investment for inflation, reducing the taxable capital gains and, consequently, the tax liability when selling the investment. This helps investors pay taxes only on the real (inflation-adjusted) gains, potentially lowering their tax burden.

Types of Mutual Funds and Their Long-Term Capital Gain Tax

There are different types of mutual funds, and each type is taxed separately. Here’s a table to understand the taxation on each type of mutual fund.

Mutual Fund FundApplicable LTCG Tax
Equity Funds10% on gains above ₹1 lakh with no indexation
Equity-Oriented Hybrid Funds10% on gains above ₹1 lakh with no indexation
Debt Funds and Debt-Oriented Funds20% tax rate and indexation benefit available
Unlisted Equity Funds20% tax rate and indexation benefit available

Equity Mutual Funds

These mutual funds invest in the equities of different companies that can offer potential returns.

Under equity funds, tax-saving funds are available, popularly known as Equity-Linked Savings Scheme (ELSS). ELSS funds come with a lock-in period of 3 years, where the investor cannot sell or redeem their fund units till the end of the lock-in period.

There are other equity funds, which do not have any lock-in period. These funds allow the investor to sell or redeem their funds at any time from the date of purchase. The capital gains on these equity funds are taxed as per the holding period. Long-term capital gains above ₹1 lakh are taxed at 10% + 4% Cess, and no indexation benefit is provided.

For example, assume you have invested ₹5 lakh in an equity fund and sold the fund after 4 years for ₹7 lakh. In this case, the capital gains on the fund is ₹2 lakh. As the capital gains are more than ₹1 lakh, the gains are taxed at 10% + 4% Cess.

Cess is a type of tax that is collected by the state or central government for a specific purpose, such as education or healthcare, and it is separate from the regular income tax.

Equity-Oriented Hybrid Funds

These funds invest in equity and debt funds. In equity-oriented hybrid mutual funds, over 65% of the investment is made towards equity or equity-oriented securities. Hence, these funds are taxed like equity funds LTCG.

Debt Funds and Debt-Oriented Funds

These funds invest in the debt instruments in the market. The LTCG on these funds are taxed at 20%, and indexation benefit is provided.

Indexation is done through the Cost Inflation Index (CII), which will reduce the capital gain amount for tax by including inflation.

The formula for the collection of CII = (Actual cost of acquisition * Index of the current year)/ Index of the base year.

Let us consider an example to understand this better. Suppose you have invested ₹5,00,000 in an equity fund in 2018 and sold the fund in 2022 for ₹8,00,000. In this case, the capital gains on the fund is ₹3,00,000. The CII in 2018 was 150; in 2022, it was 180.

The indexed cost of acquisition will be = (5,00,000 * 180)/150

= ₹6,000,000

In this case, the LTCG would be, (8,00,000 – 6,00,000) = ₹2,00,000.

Even Debt-Oriented Balanced Funds, the funds which invest over 60% in the debt market instruments, the LTCG is taxed at 20% with indexation.

Unlisted Equity Funds

These are mutual funds that invest in shares of privately held companies that are not traded on public stock exchanges. The long-term capital gains on these funds are taxed at 20% with an indexation benefit. Surcharge and cess as applicable.

Taxation on Systematic Investment Plan (SIP) Mutual Funds

The long-term capital gains tax on SIP is different from a regular mutual fund investment. Here, every instalment you make towards SIP is considered a separate investment. No tax is applicable if you invest in an SIP for 1 year or more and the gains are less than ₹1 lakh. However, there is STCG applicable to the gains from the second instalment.

For example, you invested ₹2,000 in a SIP mutual fund every month. After a year, you sell the fund at ₹15,000. Here, the capital gains are ₹3,000 (earned as ₹250 per instalment). Being less than ₹1 lakh, LTCG is not applicable. But STCG of 15% is applicable to the gains from the second month, which is ₹2,750.

What Determines the Tax on Mutual Funds?

The factors that determine the tax on mutual funds are the type of mutual funds, investment holding period, capital gains amount and if any dividends are offered on the fund.

How Are Long-Term Capital Gains Calculated on Mutual Funds?

Let us consider an example to understand how to calculate the LTCG on mutual funds. Assume you have invested in an equity mutual fund of ₹2,00,000 for 4 years and sold the fund units for ₹7,00,000.

First, calculate the profit on the investment. As per the example, you made a profit of ₹5,00,000. As this is an equity fund, there is no indexation benefit offered. And the capital gains are more than ₹1 lakh, so the LTCG is taxed at 10% + 4% Cess. This way, based on the fund type, holding period and capital gain amount, you can calculate the taxation.

Tax Exemptions on Capital Gains

Long-term capital gains on mutual funds come with certain exemptions as follows:

Section 10(38) – As per this section, LTCG occurring after the transfer of equity shares or equity-oriented mutual funds are exempted from tax if:

  • The transfer is done on or after October 1, 2004.
  • It is a long-term asset.
  • The sale transaction is liable to the security transaction tax.

Section 54F – As per this section, you can get tax benefits on the sale of an asset from LTCG on mutual funds. This exemption can be claimed if:

  • You have to buy an asset one year before or after two years from the sale date.
  • You have constructed a property using your capital gain from the sale. The construction should be done within three years from the transaction date.

Conclusion

While investing, make sure that you are well aware of the taxes levied on your investment gains. This way, you know how much you can expect from an investment approximately and adjust your investment goals accordingly.

FAQs

Do we need to pay taxes on mutual funds every year?

No. Mutual funds attract tax only when you sell the fund units. However, if your mutual fund investment offers dividends, you may have to pay tax on the dividend income if you come under the income tax slab.

What is the tax levied on Equity Linked Saving Schemes (ELSS)?

As per Section 80C of the Income Tax Act, on investing in ELSS funds, you can get up to ₹1.5 lakh in tax deduction. But note that ELSS funds come with a lock-in period of 3 years minimum.

Are there any tax-free mutual funds?

There are no tax-free mutual funds. However, ELSS funds come with a deduction of ₹1.5 lakh. Also, if your mutual fund’s capital gains are less than ₹1 lakh, the gains are not taxed.

Is wealth tax applicable to mutual funds?

No. As per the Wealth Tax Act, mutual funds are exempted from attracting any wealth tax.

As an enthusiast with extensive knowledge in the realm of mutual fund investments and capital gains taxation, I bring forth a wealth of information to guide you through the intricacies of this financial landscape. My expertise is grounded in both theoretical understanding and practical application, making me well-equipped to dissect the various concepts covered in the article.

Let's delve into the key concepts addressed in the article:

Capital Gains:

Definition: Capital gains encompass profits derived from investments like stocks, real estate, and mutual funds.

Types:

  1. Short-Term Capital Gains (STCG): Gains from investments held for one year or less.
  2. Long-Term Capital Gains (LTCG): Gains from investments held for more than one year.

Long-Term Capital Gain Tax on Mutual Funds:

  • Trigger: Taxes apply when mutual funds are held for over a year, and capital gains exceed ₹1 lakh.
  • Rate: LTCG tax rate is 10% with no indexation benefit.
  • Historical Change: Finance Bill 2018 eliminated Section 10(38), changing the tax landscape for mutual fund capital gains.

Types of Mutual Funds and Their Long-Term Capital Gain Tax:

  1. Equity Funds:

    • Tax Rate: 10% on gains above ₹1 lakh with no indexation.
    • Tax Calculation: Example provided, detailing calculation for equity funds.
  2. Equity-Oriented Hybrid Funds:

    • Taxed like equity funds, with a 10% rate on gains above ₹1 lakh.
  3. Debt Funds and Debt-Oriented Funds:

    • Tax Rate: 20% with indexation benefit.
    • Indexation Process: Utilizes Cost Inflation Index (CII) for adjusting the purchase price for inflation.
  4. Unlisted Equity Funds:

    • Tax Rate: 20% with indexation benefit, surcharge, and cess.

Taxation on Systematic Investment Plan (SIP) Mutual Funds:

  • SIP Taxation: Each SIP installment considered a separate investment.
  • LTCG: No tax if invested for 1 year or more and gains are under ₹1 lakh.
  • STCG: Applicable from the second installment.

Factors Determining Tax on Mutual Funds:

  • Determinants: Type of mutual fund, investment holding period, capital gains amount, and dividend offerings.

Calculating Long-Term Capital Gains on Mutual Funds:

  • Example: Walkthrough on calculating LTCG for an equity mutual fund investment.

Tax Exemptions on Capital Gains:

  1. Section 10(38): Exemption for LTCG on equity shares or equity-oriented mutual funds meeting specific criteria.

  2. Section 54F: Tax benefits on LTCG from mutual funds if invested in specified assets within a given timeframe.

Conclusion:

  • Investor Awareness: Emphasis on understanding tax implications to align investment goals.

FAQs:

  1. Tax Payment Frequency: Taxes on mutual funds incurred upon selling fund units, not annually.

  2. ELSS Taxation: ELSS funds offer tax deduction under Section 80C with a 3-year lock-in.

  3. Tax-Free Mutual Funds: No entirely tax-free mutual funds, but gains below ₹1 lakh are not taxed.

  4. Wealth Tax on Mutual Funds: Mutual funds are exempt from wealth tax under the Wealth Tax Act.

In conclusion, navigating the landscape of mutual fund investments requires a nuanced understanding of capital gains taxation. With the right knowledge, investors can make informed decisions to optimize their financial growth while staying compliant with tax regulations.

Long-Term Capital Gain Tax on Mutual Funds in India | Angel One (2024)

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