All About Capital Gains Tax on Mutual Funds   Nov 20, 2017


Profits or gains arising from transfer of an asset, also known as a ‘capital asset’, such as mutual funds, property, gold, shares, and bonds are considered as capital gains and are taxed under the income head ‘capital gains’.

Such capital gains are of two types—short-term capital gains (STCG) and long-term capital gains (LTCG)—depending on the period of holding. Both these categories attract a different set of capital gains tax rates, depending on the asset type.

Here we will only discuss capital gains tax on mutual funds.

Every mutual fund transaction has a tax implication. This depends on the nature of the asset and the period of holding. Unfortunately, prior to investing in mutual funds, specifically debt or non-equity mutual funds, many ignore the implications of capital gains tax on their investment.

Capital gains tax on mutual fund holdings is established upon whether you hold equity oriented funds or non-equity oriented funds.

Equity oriented funds are defined as those in which 65% of the investible corpus in invested in Indian equities.

Non-equity funds are those which invest less than 65% in Indian equities – these include debt funds (such as income funds, liquid funds, gilt funds, floating rate funds, Fixed Maturity Plans (FMPs), Monthly income Plans, (MIPs), Gold ETFs and so on. Notably, even fund-of-funds which may invest indirectly in Indian equity through other mutual funds are not considered as equity funds.

What is the tax on capital gains for mutual funds?

  Individual/HUF Domestic Company NRI
Equity Oriented Schemes

LTCG (units held for more than 12 months) , STCG (units held for 12 months or less)
Long Term Capital Gains Nil Nil Nil
Short Term Capital Gains 15%+ Surcharge as applicable + 3% Cess 15%+ Surcharge as applicable + 3% Cess 15%+ Surcharge as applicable + 3% Cess
       
Non-equity Oriented Schemes

LTCG (units held for more than 36 months) , STCG (units held for 36 months or less)
Long Term Capital Gains 20% with indexation + Surcharge as applicable + 3% Cess 20% with indexation + Surcharge as applicable + 3% Cess 20% with indexation + Surcharge as applicable + 3% Cess
Short Term Capital Gains 30%^ + Surcharge as applicable + 3% Cess 30% + Surcharge as applicable + 3% Cess

25%^^^ +Surcharge as applicable + 3% Cess
30%^ + Surcharge as applicable + 3% Cess
^ - Assuming the investor falls into highest tax bracket.
^^^-If total turnover or Gross receipts during the financial year 2015-16 does not exceed Rs. 50 crores.
(Source: Personal FN Research)

As can be seen in the table above, for equity oriented funds, while the capital gains tax implication for long term capital gains (LTCG) are nil, Short Term Capital Gains (STCG) are taxed at 15%.

For non-equity oriented funds, long-term capital gains are taxed at 20% with indexation.

Indexation lets an individual adjust the purchase price of the mutual fund units by taking into account inflation, thus enabling them to reduce your tax outgo.

Short-term capital gains for non-equity oriented funds are added to the total income and taxed as per one’s tax slab, which means that if the 30% tax bracket applies to you, short-term capital gains arising from the sale of your mutual fund units will be taxed at 30%.

This means that the tax is calculated on mutual fund units on a First-in-First-out basis. So, if you have invested via a Systematic Investment Plan (SIP), do pay attention to check that the units you are redeeming met the requisite tax guidelines.

For example, if you started an SIP in an equity fund on October 5, 2016, and plan to redeem or switch all your investments on November 25, 2017. Only gains on units purchased on October 5, 2016 and November 5, 2016, will be tax-free. For units purchased in the subsequent months will attract short-term capital gains tax.

Therefore, it is important to consider the tax implications before investing or redeeming your money from mutual funds.

Tax Deduction at Source (TDS) by Mutual Funds for NRIs

Tax Deduction at Source is applicable on gains for NRI investors. This short-term or long-term capital gain tax will be deducted at the time of redemption of units in case of NRI investors only.

Below is the table with the applicable tax rates.
Tax Deducted at Source (Applicable only to NRI Investors)
Short term capital gains Long term capital gains
Equity oriented schemes 15%+ 15%/10% Surcharge+3% Cess Nil
Other than equity oriented schemes (Listed) 30%^ + 15%/10% Surcharge + 3% Cess 20%+ 15%/10% Surcharge + 3% Cess
Other than equity oriented schemes (Unlisted) 30%^ + 15%/10% Surcharge + 3% Cess 10%+15%/10% Surcharge + 3% Cess
^ - Assuming the investor falls into highest tax bracket. (Source: PersonalFN Research)

How is long-term capital gain indexation calculated?

Let’s look at this example:

Suppose you have invested Rs 10,000 in a short-term debt fund on May 15, 2013. And, you decide to sell these units on November 10, 2016. The redemption value is Rs 13,000. The holding period is approximately 42 months. So in this case, because your holding period is greater than 36 months, your long term capital gains is Rs 3,000 (Rs13000-Rs10000).

However, tax will be charged on the indexed gains. The indexed capital gains tax is calculated as below:
Particulars Amount (Rs.)
Cost of Purchase (P) 10,000
CII- year of purchase (2013-14)* (a) 220
CII-year of sale (2016-17)* (b) 264
Adjusted cost of purchase (P*b/a) 12,000
Taxable gains - with indexation (Rs 13,000 - Rs 12,000) (A) 1,000
Tax rate 20% + Cess 3%, excluding surcharge^ (B) 20.60%
Tax payable on gains (A*B) 206
*Cost of Inflation Index, ^Surcharge applicable if income is greater than Rs 50 lakh
(Source: PersonalFN Research)

Let’s say, on account of demonetisation, you put off your redemption to April 20, 2017. On the redemption date, due to the volatility in the bond market, your redemption value remains the same at Rs 13,000. Here again, your gains will be Rs 3,000. The holding period is about 47 months.

However, when you redeem these in another financial year, your indexed cost will be different. Take a look at the calculation below:
Particulars Amount (Rs.)
Cost of Purchase (P) 10,000
CII- year of purchase (2013-14)* (a) 220
CII-year of sale (2017-18)* (b) 272
Adjusted cost of purchase (P*b/a) 12,364
Taxable gains - with indexation (Rs 13,000 - Rs 12,000) (A) 636
Tax rate 20% + Cess 3%, excluding surcharge* (B) 20.60%
Tax payable on gains (A*B) 131
*Cost of Inflation Index ^Surcharge applicable if income is greater than Rs 50 lakh

(Source: PersonalFN Research)

Therefore, even though the redemption value is the same, by extending your redemption by just 5 months, you’ll  be able to reduce your tax outgoes.

Below is the New Cost of Inflation Index:

New Cost of Inflation Index

Financial Year CII
2001-02 100
2002-03 105
2003-04 109
2004-05 113
2005-06 117
2006-07 122
2007-08 129
2008-09 137
2009-10 148
2010-11 167
2011-12 184
2012-13 200
2013-14 220
2014-15 240
2015-16 254
2016-17 264
2017-18 272
(Source: CBEC)

Is capital gains tax applicable on Switch transactions?

Yes, any redemption that results in capital gains will attract tax. Even if you switch from the regular plan to the direct plan or vice-versa, the capital gains tax rules will apply.

However, if a mutual fund scheme is merged or different plans of a scheme are merged, and you continue to hold on to your units, the date of your initial investment will be considered when calculating capital gains and not the date of the merger.

To conclude...

The calculation of capital gains tax is important. If all this seems too much of a task to do, it would be prudent to consult with an expert. After all, no one wants his or her hard-earned money to be wiped away because of negligence. Hire a financial planner who is ethical and devoid of any biases. Choose a Certified Financial Guardian (CFG) who will safeguard your financial interests. A financial guardian is trustworthy; an advisor who puts your interest before their own.

Choosing the best mutual funds and paying attention to tax liability is both equally important. The post-tax returns should be estimated when planning for your financial goals.

If you seek unbiased investment advice, opt for PersonalFN’s Financial Planning Services Through the Financial Planning Service, create a holistic Financial Plan that takes into account all current financial positions and suggests how to achieve your financial goals.

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