The Union Budget 2024, presented in July this year, introduced some major changes to the tax rules for mutual fund investments, impacting both short-term and long-term capital gains. Investors selling mutual fund units within a year will now face a higher tax rate on their profits. For those holding investments for over a year, the tax on long-term capital gains has slightly increased. However, small investors will benefit from a raised tax-free limit on long-term capital gains, now set at Rs 1.25 lakh.
Mohammed Chokhawala, a tax expert at ClearTax, explains the changes in taxation rules introduced in the Union Budget that affect mutual fund investments.
Taxation on mutual funds in India varies based on the type of mutual fund (equity and debt) and the duration for which the investment is held, he said adding that each type of mutual fund is subject to different rules for calculating capital gains and tax liabilities. “For instance, equity mutual funds and debt mutual funds have distinct holding periods that determine whether the gains are categorized as short-term or long-term, with varying tax rates applicable to each.”
Understanding these differences is essential for investors to maximize returns while minimizing their tax burden, he stressed as he explained tax implications on various types of funds.
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Income Tax Implications on Equity Mutual Funds:
Short-Term Capital Gains (STCG): Gains from the sale of equity mutual fund units held for less than 12 months are classified as Short-Term Capital Gains (STCG). These gains are taxed at 20% for transfers occurring on or after 23rd July 2024 and at 15% for transfers made before this date.
Long-Term Capital Gains (LTCG): Gains from the sale of equity mutual fund units held for over 12 months are classified as Long-Term Capital Gains (LTCG). For gains exceeding Rs 1,25,000 in a financial year, a tax of 10% applies to those realized before 23rd July 2024, and 12.5% for gains realized on or after this date.
Investors will need to strategize their LTCG to stay within the Rs 1.25 lakh exemption, encouraging smaller investors to invest more for tax-free gains. Additionally, the increase in STCG tax from 15% to 20% for listed shares is likely to push them to start thinking about long-term trading strategies for their investments.
Equity mutual funds, as per the Income Tax Act, 1961, refer to mutual funds that allocate at least 65% of their assets to equity shares of domestic companies.
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Income Tax Implications on Debt Mutual Funds:
Taxation of debt mutual funds before 1 April 2023:
Earlier, the taxation of debt mutual funds was governed by the holding period rule:
Short-Term Capital Gains: If the debt mutual fund units were sold within 36 months (three years) of purchase, the gains termed short-term capital gains (STCG). These STCGs were taxed at slab rates.
Long-Term Capital Gain: However, if they were sold after 36 months, then the gains were termed long-term capital gains (LTCG). These long-term capital gains were taxed at 20% with an indexation benefit. Indexation benefit means the gains made by investors were adjusted for inflation.
Taxation of debt mutual funds on or after 1 April 2023:
From 1 April 2023, debt mutual funds are taxed at the taxpayer’s applicable slab rates irrespective of the holding period. This change has negatively impacted debt mutual fund investors, as it has led to an increase in their tax liability.
Debt mutual funds, as per the Income Tax Act, 1961, refer to mutual funds that allocate less than 65% of their assets to equity shares of domestic companies.
Disclaimer: The above content is for informational purposes only. Mutual Fund investments are subject to market risks. Please consult your financial advisor before investing.