Taxes while investing in Mutual Funds
Alright. By now I’m hoping that all (or at least most) of you have started investing in Mutual Funds.
If not, you’re missing the rally! Start investing now!
And for those of you who have invested and are looking at selling to book profits, you may be wondering how taxation works in case of Mutual Funds.
The government as well as the Income Tax department does a fantastic job at confusing us with jargon and complicated tax slabs. :p
But don’t worry. You’re a subscriber to Personal Finance India. Here, we’ll simplify it in less than 5 minutes.
By the way, even if you’re not looking at selling your Mutual Funds today, do bookmark this page/star this email and keep, for future reference. Well, you WILL need to sell them at some point in time in life to enjoy the profits.
Anyway, coming back. When it comes to Mutual Funds, there are 2 kinds of taxes that are applicable, irrespective of the kind of fund it is (debt/equity/hybrid). These are LTCG (Long Term Capital Gains) tax and STCG (Short Term Capital Gains) tax.
As the names suggest, depending on the duration in which you hold the Mutual Fund, you will pay LTCG or STCG tax. Now, the definition of “long term” and “short term” are different for equity and debt funds. For an equity fund, anything greater than 1 year is termed as long term and for debt fund anything more than 3 years is termed long term. So basically if you hold an equity fund for less than 1 year, you will pay STCG and if you hold it for more than 1 year, you’ll pay LTCG. For debt funds, this benchmark is 3 years.
Now coming to the tax rates. Have a look at the table below to understand the STCG and LTCG applicable to you depending on how long you have held your investments.
* For debt funds, if you have held them for the long term. You can avail indexation benefit
Note: LTCG upto Rs. 1 lakh on equity is exempt from tax, which means as long as your LTCG in Equity funds is less than Rs. 1 lakh, you need not pay any tax on it.
(For those who are confused about debt funds, if you hold a debt fund for less than 3 years, it is taxed as per your Income Tax slab. If held for more than 3 years, it is taxed at 20%)
Now, what is indexation benefit, you may ask?
Basically, if you purchased a Mutual Fund say, 5 years ago and are selling it today, the cost of purchasing anything 5 years ago is not the same today, due to inflation. Therefore, with indexation benefit, the cost of the debt fund is indexed (or adjusted) to today, based on the inflation rates. The calculation for this will need some more explanation, so I’ll do that in another article. However, for now, it will suffice to understand what indexation means - which basically is an adjustment of the cost price of your Mutual Fund as per inflation. So if you’ve purchased units at Rs. 100, after indexation, the price will come to something like Rs. 120/130 or so. Which means your capital gains will reduce and therefore tax will reduce. Indexation therefore, is a good way to optimize taxes :)
Well, that’s all there is to taxation in Mutual Funds. As long as you don’t have a profit of more than Rs. 1 lakh in equity funds and hold it for >1 year, it is not taxed. Debt funds are taxed irrespective of your capital gain amount, with indexation benefit.
Let me also cover a concept called Tax Loss harvesting here. This is really important if you want to save tax on your Mutual Funds.
Simply put, tax loss harvesting is a concept that can help you reduce your tax liability on Mutual Funds if you have incurred a loss.
For example, if you purchased Mutual Fund A for Rs. 2,00,000 and sold it for Rs. 3,50,000 after 2 years, you made a profit of Rs. 1,50,000. In the same duration, you made a loss of Rs. 60,000 on another Mutual Fund B. You purchased it at Rs. 1,00,000 but sold it at Rs. 40,000.
Now, your net capital gain is (1,50,000-60,000) = Rs. 90,000. Therefore the tax you will pay, will be only on Rs. 90,000 and not Rs. 1,50,000. Depending on whether it was a debt or equity fund, your tax will be applicable. However, the tax will be on your NET capital gain of Rs. 90,000 only.
Now here’s the interesting part - you can carry forward your losses for 8 years! So if you have made a capital loss today, this loss can be offset against any capital gains that you may have, till 8 years. This is a great tax-saving provision that a lot of people tend to ignore.
But you won’t be one of them, since you’re aware of capital gains taxes pretty well now! ;)
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Have a great Sunday!