Long-term capital gains tax on mutual funds

Posted On: 20 October 2023

Long Term Capital Gains (LTCG) Tax is levied on the profits earned from selling mutual fund units after holding them for a specified period. LTCG impacts how investors manage their investment strategies and tax liabilities. Understanding LTCG tax implications is essential for investors aiming to optimise their returns and comply with tax regulations effectively.

Table of contents

What is long-term capital gain tax on mutual funds?
Long term capital gains tax rates
How to calculate LTCG tax?
Tax Implication on Systematic Investment Plan
How to minimize tax on long term capital gains?

What is long-term capital gain tax on mutual funds?

Capital gains on capital assets held for more than a certain period are considered long-term capital gains (LTCG). The holding period can vary based on the asset. For most assets, the holding period is 24 months, meaning that gains on assets held for more than two years will be eligible for long-term capital gains tax. However, for units of equity-oriented mutual funds, the holding period to qualify for LTCG tax is one year. This tax is structured to encourage long-term investment by offering preferential rates compared to short-term capital gains, which are taxed at higher rates. Understanding these distinctions is crucial for investors to effectively plan their investment timelines and tax strategies.

Long term capital gains tax rates

Taxation of mutual funds varies based on the type of funds—equity or debt—and the duration of investment. Here’s a quick look at the taxation rates:

Equity and equity-oriented funds: Mutual funds are subject to taxation based on investment duration and the type of securities involved. As per the 2024 Union Budget, gains from equity and equity-oriented funds held for over 12 months are classified as Long-Term Capital Gains (LTCG). The LTCG tax rate for mutual funds is 12.5% (plus applicable surcharges and 4% cess) if gains exceed Rs. 1.25 lakh in a financial year.

Profits on units held for less than a year will be considered short-term capital gains and taxed at 20%, with no exemption limit.

Debt and debt-oriented funds: For debt funds, gains are added to the investor's taxable income and taxed according to their respective income tax slab, irrespective of the holding period. This change was introduced in the Union Budget 2023 and is applicable to units acquired on or after April 1, 2023.

Indexation: Debt mutual funds previously offered indexation benefits on long-term capital gains (for units held for more than 36 months), which allowed investors to adjust their purchase price of mutual fund investments to account for inflation, reducing tax liabilities on gains. However, indexation benefits on debt mutual funds were removed in Budget 2023 and is not applicable on units purchased after April 1, 2023.

How to calculate LTCG tax?

The LTCG tax rate for equity-oriented assets, such as units of equity mutual funds and shares of listed companies, is 12.5% on gains exceeding Rs. 1,25,000. Gains up to Rs. 1,25,000 are exempt from tax. Here’s a sample calculation. Let’s assume you made a lump sum investment in an equity-oriented mutual fund that generates a 12% return. In the first scenario, you withdraw all your units after 10 years. In the second scenario, you redeem all your units after 19 years. Here’s the LTCG tax rate you will need to pay.

Invested Amount	Holding Period	Value at Redemption	Capital Gains	Post Exemption Gains	LTCG Tax*
1,00,000	10 years	Rs. 3,10,585	Rs. 2,10,585	Rs. 85,585	Rs. 10,698
1,00,000	19 years	Rs. 8,61,276	Rs. 7,61,276	Rs. 6,36,276	Rs. 79,534

Tax implications on Systematic Investment Plan

When investing in mutual funds through a Systematic Investment Plan (SIP), different units have different holding periods, depending on when the investment was made. So, upon redemption, the tax rate will depend on how long the redeemed units were invested. The rate is as follows:

For equity-oriented mutual funds, units held for over 12 months will qualify for long-term capital gains (LTCG) tax.
Units held for less than 12 months will qualify for short-term capital gains tax and will be taxed at 20%.

This approach ensures that the tax treatment aligns with the duration of each investment made through SIP.

How to Minimize Tax on Long-Term Capital Gains

Minimizing tax on long-term capital gains (LTCG) involves strategic planning and utilizing available tax-saving methods. Here are some strategies:

Hold investments for longer periods: LTCG tax rates for equity-oriented funds are lower compared to short-term capital gains (STCG). Therefore, you can reduce the tax burden by holding these units for at least a year.
Offset gains with losses: Offset LTCG from profitable investments by selling other investments that have incurred losses. This strategy, known as tax-loss harvesting, can reduce your overall taxable income.
Invest in Equity Linked Savings Scheme (ELSS): ELSS provides tax benefits similar to equity mutual funds while ensuring a lower LTCG tax rate over a three-year lock-in period.
Use the annual exemption limit: LTCG tax is applicable only if the LTCG exceeds Rs. 1.25 lakh in a financial year. Utilize this exemption by managing your withdrawals strategically.
Consider systematic withdrawals: Instead of withdrawing a lumpsum, opt for systematic withdrawals which can spread your tax liability over multiple years, potentially reducing the impact of LTCG tax in any single year.

Conclusion

In conclusion, long-term capital gains are profits that investors get from the sale of equity and equity-oriented funds after holding them for over 12 months. LTCG are taxed at a lower rate than STCG. A sound knowledge of these tax implications can help investors create investment strategies and make well-rounded investment decisions to maximize the return potential of their investments.

FAQs

What are the tax benefits of investing in Equity Linked Saving Schemes (ELSS)?

By investing in ELSS, you can avail tax deductions under section 80C of the Income Tax Act, 1961. ELSS investments are subject to a lock-in period of 3 years and are eligible for a tax deduction of up to Rs. 1.5 lakh.

What are capital gains in mutual funds?

capital gain in mutual fund arises when there is an appreciation in the price of mutual fund units. The capital gains from mutual funds are usually taxed in the hands of investors.

How to reduce long term capital gain tax?

Reduce LTCG tax by holding investments for over a year, offsetting gains with losses, utilizing other tax-exempt investment avenues, and planning withdrawals strategically.

What is the LTCG for equity funds?

LTCG on equity funds held for over a year is taxed at a flat rate of 12.5% on gains exceeding Rs. 1.25 lakh in a financial year, without indexation benefits, offering a tax-efficient investment option for long-term wealth creation.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.