Long-Term Capital Gain Tax on Mutual Funds

Overview on Long-Term Capital Gain Tax on Mutual Funds

Long-term capital gains are the gains that arise when long-term capital asset is transferred. The taxation of LTCG under Income-tax Act,1961 is categorised  into two provisions i.e. Section 112 and Section 112A. Section 112A specifically addresses the taxation of LTCG on listed shares, equity-oriented funds, and units of a business trust. In this article, we will discuss about Section 112A.

Investing in mutual funds in India has become increasingly popular due to their potential for substantial returns and diversification benefits.

Understanding the tax implications of these investments, particularly long-term capital gains (LTCG), is crucial for investors.

Long-term capital gains refer to the profit earned from the sale of mutual fund units that have been held for more than 12 months. The duration of holding is key in distinguishing between long-term and short-term capital gains, with the latter being applicable to holdings of 12 months or less.

whereas gains from unlisted equity shares will be considered long-term only if they are held for at least 24 months.

 

What is a Long-Term Capital Gain Tax on Mutual Funds?

A Long-Term Capital Gain tax on mutual funds in India refers to the profit earned from the sale of mutual fund units that were held for a period exceeding one year. The taxation on LTCG differs based on the type of mutual fund.

1. Equity Mutual Funds:
   • These funds invest predominantly (at least 65% of their portfolio) in equities or equity-related instruments.
   • LTCG on equity mutual funds is exempt from tax for gains up to ₹1 lakh in a financial year.
   • Gains exceeding ₹1 lakh are taxed at 10% without the benefit of indexation.
2. Debt Mutual Funds:
   • These funds invest in debt securities, such as government bonds, corporate bonds, and money market instruments.
   • LTCG on debt mutual funds is applicable if the units are held for more than three years.
   • The gains are taxed at 20% with the benefit of indexation, which allows adjustment for inflation.
3. Hybrid or Balanced Mutual Funds:
   • The taxation depends on the allocation of the fund. If the equity exposure is more than 65%, they are treated as equity funds for tax purposes. Otherwise, they are treated as debt funds.

Example: Mr. A has an LTCG on listed shares of Rs. 3,00,000. Calculate the tax liability on the same.

Tax liability on listed shares = (3,00,000 – 1,00,000) * 10% = Rs. 20,000.

Key takeways of section 112A of income tax act

Section 112A of the Income Tax Act in India primarily deals with the taxation of long-term capital gains (LTCG) arising from the transfer of equity shares or units of equity-oriented mutual funds. Here are the key takeaways of Section 112A:

1. Applicability: Section 112A applies to LTCG on the transfer of equity shares in a company or units of an equity-oriented fund, where the transaction is subject to Securities Transaction Tax (STT).
2. Rate of Tax: LTCG exceeding Rs. 1 lakh arising from such transfers is taxed at a flat rate of 10% (effective from Assessment Year 2019-20 onwards).
3. Cost Inflation Index (CII): Indexation benefit (adjustment for inflation using the Cost Inflation Index) is not allowed for calculating LTCG under Section 112A. The gains are computed by deducting the cost of acquisition/improvement and expenses incurred in connection with the transfer from the full value of consideration received or accruing.
4. Grandfathering Provision: For equity shares or units acquired before 1st February 2018, the cost of acquisition can be either the actual cost or the fair market value as on 31st January 2018, whichever is higher. This ‘grandfathering’ ensures that only the appreciation in value post 31st January 2018 is taxed.
5. Exemption Limit: LTCG up to Rs. 1 lakh in a financial year is exempted from tax under Section 112A. Only the amount exceeding Rs. 1 lakh is taxable at 10%.
6. Reporting and Filing: Taxpayers need to report LTCG from such transactions in their income tax returns (ITRs), providing details such as the nature of asset, sale consideration, cost of acquisition, and LTCG amount.
7. Non-applicability: Section 112A does not apply to short-term capital gains (STCG) from equity shares/units, which continue to be taxed at 15%.

What are the Tax Implications on Different Types of Mutual Funds?

Below are the different types of mutual funds and the tax provisions applicable to each of them –

1. Equity Funds:
   • These funds invest in equity shares of various companies.
   • Tax-saving equity funds (ELSS) have a 3-year lock-in period.
   • Long-term capital gains (LTCG) on equity funds are taxed at 10% if gains exceed Rs.1 lakh.
   • Example: Mr. X’s investment resulted in a long-term capital gain of Rs.2 lakhs, taxed at 10% (Rs.20,000).
2. Equity-Oriented Hybrid Funds:
   • Invest in both equity shares and debt instruments.
   • Tax treatment similar to equity funds due to significant equity exposure.
3. Debt Funds:
   • Invest in debt instruments.
   • Long-term capital gains taxed at 20% after indexation benefit.
   • Indexation adjusts for inflation, reducing taxable gain.
4. Debt-Oriented Balanced Funds:
   • Invest in both equity and debt (60% debt, 40% equity).
   • Taxed at 20% (with indexation benefit).
5. Unlisted Equity Funds:
   • Long-term capital gains taxed at 20% after indexation.
   • Includes cess tax and surcharge.
   • Option to choose indexation benefits or not.

 

Example Scenario of Without Indexation Benefit

Purchase Details:

• Purchase Price: ₹100,000
• Purchase Date: April 1, 2010

Sale Details:

• Sale Price: ₹500,000
• Sale Date: April 1, 2024

Cost Inflation Index (CII):

• CII for FY 2010-11: 167
• CII for FY 2023-24: 348

Long-Term Capital Gain Calculation:

1. Sale Price: ₹500,000
2. Purchase Price: ₹100,000

Long-Term Capital Gain (LTCG) without Indexation:

LTCG=Sale Price−Purchase Price

LTCG=₹500,000−₹100,000

LTCG=₹400,000

Example Scenario of With Indexation Benefit

Long-Term Capital Gain (LTCG) with Indexation:

1. Sale Price: ₹500,000
2. Indexed Purchase Price: ₹208,383

LTCG with Indexation:

LTCG=Sale Price−Indexed Purchase Price

LTCG=₹500,000−₹208,383

LTCG=₹291,617

Summary

• LTCG without Indexation: ₹400,000
• LTCG with Indexation: ₹291,617

Tax Implications

• The tax rate on LTCG for unlisted shares without indexation is 10%.
• The tax rate on LTCG for unlisted shares with indexation is 20%.

Tax Payable

1. Without Indexation: Tax = 10% × ₹400,000 = ₹40,000
2. With Indexation: Tax = 20% × ₹291,617 = ₹58,323.40

Conclusion

• Tax without Indexation: ₹ 40,000
• Tax with Indexation: ₹ 58,323.40

In this example, the tax payable is higher with indexation benefits because the indexed cost is higher, reducing the capital gain, but the tax rate is higher for gains with indexation.

 

Long-term Capital Gains on Systematic Investment Plans (SIP) Taxed?

Long-term capital gains (LTCG) on Systematic Investment Plans (SIPs) are subject to specific tax rules in India. Here’s a breakdown of how they are taxed:

1. Definition of Long-term Capital Gains (LTCG)

For equity mutual funds, including SIPs:

• Long-term: Gains on units held for more than 12 months.

2. Tax Rate

• LTCG up to ₹1 lakh in a financial year is exempt from tax.
• LTCG exceeding ₹1 lakh is taxed at 10% without the benefit of indexation.

3. Calculation of Holding Period

Each SIP installment is treated as a new investment, so the holding period for each installment must be calculated individually.

• For instance, if you have been investing monthly in an SIP for two years and you redeem your investment, each SIP installment will have a different holding period, depending on the date of investment.

4. Example

• Assume you invest ₹10,000 every month in an equity mutual fund SIP starting January 2023.
• If you redeem the entire amount in February 2024, only the installments from January 2023 to February 2023 would qualify for LTCG (since they have been held for more than 12 months).

5. Computation of LTCG

• Compute the gains separately for each installment based on the purchase and sale price.
• Aggregate the gains from all the long-term holdings.
• If the total LTCG exceeds ₹1 lakh, the excess amount is taxed at 10%.

6. Indexation Benefit

• The 10% tax on LTCG exceeding ₹1 lakh is without the benefit of indexation, meaning the cost of acquisition is not adjusted for inflation.

7. Example Calculation

Let’s say you have the following SIP installments and redemption values:

Installment Date	Amount Invested	NAV on Purchase	Units Bought	NAV on Redemption	Value on Redemption	Gain	LTCG?
Jan 2023	₹10,000	₹100	100	₹120	₹12,000	₹2,000	Yes
Feb 2023	₹10,000	₹105	95.24	₹120	₹11,429	₹1,429	Yes
…	…	…	…	…	…	…	…
Dec 2023	₹10,000	₹110	90.91	₹120	₹10,909	₹909	No
Jan 2024	₹10,000	₹115	86.96	₹120	₹10,435	₹435	No

• Total LTCG for the year = Sum of gains from Jan 2023 to Feb 2023 = ₹2,000 + ₹1,429 = ₹3,429 (assuming other months follow the same pattern).
• Taxable LTCG = ₹3,429 – ₹1,00,000 = (-₹96,571), which is not taxable as it is below the threshold of ₹1 lakh.

Summary

LTCG on SIPs are taxed at 10% for gains exceeding ₹1 lakh in a financial year, with each installment considered separately for the holding period.