Mutual funds are a popular investment instrument among investors who prefer not to invest in the stock market directly. They are managed by an expert fund manager, have a diversified portfolio, are cost-effective, and come with tax benefits.
That said, when you invest in mutual funds, you have to bear capital gains tax. Therefore, it's essential to understand how taxes on mutual funds work if you're looking to maximize your returns while minimizing your tax liability.
In this blog, we'll look closer at the long-term capital gain tax on mutual funds and how you can minimize its impact on your investment returns.
If you sell your mutual funds after holding the units for more than one year, you must pay a long-term capital gains (LTCG) tax if the profits earned from the sale exceed Rs. 1 lakh. The tax rate depends on the type of mutual funds you own.
If you've invested in equity mutual funds, you will be taxed at 10%. For non-equity mutual funds, the LTCG tax rate is 20% after indexation. Indexation is a technique that adjusts the price of mutual fund units for inflation, reducing your capital gains tax liability.
LTCG tax on mutual funds varies depending on the type of funds you've invested in and the amount you're holding. Here's how:
1. LTCG on equity funds
LTCG will be applicable on equity mutual funds on profits earned from selling units held for more than a year. However, in the case of tax-saving equity mutual funds, called equity-linked savings schemes (ELSS), your funds will be locked in for a period of 3 years. During this time, you can't sell your mutual fund units. You'll have to pay LTCG on these tax-saving funds after they mature. LTCG on equity funds is taxed at 12.5% for gains exceeding Rs. 1.25 lakhs in a financial year. If your gains are below Rs. 1'25 lakhs, you're exempt from tax.
2. LTCG on equity-oriented hybrid funds
Equity-oriented hybrid funds are mutual funds that invest at least 65% of their assets in equities. This enables them to qualify for equity taxation rules and benefit from potential capital appreciation. LTCG on equity-oriented hybrid funds is treated similarly to standard equity funds. If your gains exceed Rs. 1.25 lakhs, you'll be taxed 10% as LTCG. However, if your gains are below Rs. 1.25 lakhs, you'll be exempt from taxes.
3. LTCG on debt funds
Debt funds invest primarily in fixed-income instruments like bonds, government securities, and corporate debt. LTCG at 12.5% without indexation benefits will be applicable on debt funds if you hold the units for more than 2 years.
4. LTCG on unlisted equity funds
Unlisted equity funds are mutual funds that invest in the equity shares of companies that are not publicly traded on any stock exchange. LTCG on these funds is taxed at 12.5% without indexation benefits if you sell the units after 2 years.
The tax implications of SIPs vary depending on the type of mutual fund and the duration of the investment:
1. Equity mutual funds:
- Short-term capital gain (STCG): STCG from equity mutual funds is taxed at 20% if you hold the units for less than a year.
- Long-term capital gains (LTCG): LTCG from equity mutual funds is taxed at 12.5% on profits exceeding Rs. 1.25 lakhs if you sell the units after 1 year.
2. Debt mutual funds
Both LTCG and STCG from debt mutual funds are added to your taxable income and taxed as per the applicable income tax slab.
Here's a quick guide to help you understand the long-term tax rates on mutual funds-
| Type of fund | Holding period | Tax rate |
| Equity-oriented fund | >12 months | 10% above Rs. 1 lakh without indexation |
| Debt fund | >36 months | 20% with indexation |
| Balanced Funds (equity-oriented) | >12 months | 10% above Rs. 1 lakh without indexation |
| Balanced Funds (debt-oriented) | >36 months | 20% with indexation |
| Hybrid Fund(more than 65% equity in total investment) | >12 months | 10% above Rs. 1 lakh without indexation |
| Hybrid Fund (less than 65% equity in total investment) | >36 months | 20% with indexation |
You can easily calculate your potential LTCG taxes by using an online long-term capital gains tax calculator. Select the type of mutual fund you've invested in, the holding period, and the sale and purchase value, and click on 'Calculate'. The long-term capital gains tax calculator will generate the result instantly.
You can also calculate the tax manually using the following method.
*Note: The LTCG rates are applicable only for investments made before 31st March 2023. Irrespective of the holding period, Capital gains from debt mutual funds will be taxed as per the investor’s income tax slab rate starting from 1 April 2023.
Before diving into the manual calculation, you must understand two important terms- cost of acquisition and full value of consideration.
The cost of acquisition is the amount at which you bought the mutual fund units. It includes the purchase price, as well as other charges like transaction fees, brokerage, stamp duty, etc.
The full value of consideration is the amount you received for selling your units.
Now, let's understand LTCG tax calculation with the help of an example. Suppose you purchased mutual fund units worth Rs. 1 lakh in 2016. You sold all units for Rs. 5 lakh in 2018. Since you held the units for more than 12 months, here's how you can calculate your LTCG tax-
Full value of consideration- Rs. 5 lakh
Cost inflation index- 280
Indexed cost of acquisition- 1 lakh X (280/100) = Rs. 2,80,000
Total taxable gain= Rs. 5,00,000 - Rs. 2,80,000= Rs. 2,20,000
Since your profit exceeds Rs. 1 lakh, you'll be taxed at 10%.
2,20,000 X 10% = Rs. 22,000
Hence, your LTCG tax is Rs. 22,000.
Suppose you invested in equity shares for Rs. 1 lakh in March 2021 and sold them for Rs. 3 lakh in March 2024. Since you held the units for more than 2 years, LTCG tax will be applicable.
Total gains = Rs. 3 lakh - Rs. 1 lakh = Rs. 2 lakh
LTCG exempt up to Rs. 1.25 lakhs.
Taxable gains = Rs. 2 lakhs - Rs. 1.25 lakhs = Rs. 75,000
LTCG tax at 12.5% = Rs. 9,525
While LTCG tax is mandatory in mutual funds, you can take a few steps to minimize your tax liability-
-Invest in tax-saving mutual funds like ELSS to claim a deduction of up to Rs. 1.5 lakh under section 80C of the IT Act.
-Opt for systematic withdrawal plans (SWPs) that allow you to redeem your mutual fund units at regular intervals. This way, you can ensure that your profits are below Rs. 1 lakh in a financial year.
-Consult a tax professional to optimize your investments and reduce your tax liability.
Mutual funds are an excellent way to invest in the stock market without spending hours monitoring it. They're also an excellent way to save taxes. But at the same time, the gains you make when selling your units attract capital gains taxes. Therefore, you must stay updated with the latest tax developments to make the most of your investments.
If you haven't invested in mutual funds yet, start today with Tata Capital Moneyfy. Our experts will evaluate your financial goals, budget, and risk appetite to determine the best fund for you. Visit the Moneyfy Website or download the Moneyfy's mutual fund investment App to know more.
Yes, long-term capital gains (LTCG) on mutual funds are taxable. For equity mutual funds, LTCG exceeding Rs. 1.25 lakhs in a year is taxed at 12.5%. For debt mutual funds, LTCG is taxed at 12.5% without indexation benefits.
While it's not possible to completely avoid capital gains taxes, you can minimize them by leveraging exemptions, holding investments for a longer duration, and investing in tax-saving funds.
Yes, for equity mutual funds, LTCG up to Rs. 1.25 lakh in a year is tax-free.
No, taxes on mutual funds depend on the duration for which you hold the units.
Yes, investments in Equity Linked Savings Schemes (ELSS) can provide a tax rebate under Section 80C of the Income Tax Act.
When selecting tax-saving mutual funds, you must consider factors like fund performance, risk tolerance, expense ratio, lock-in period, and the fund manager's expertise.
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14 November 2024
8 mins read
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