As of 1 April 2018, the long term capital gains (LTCG) on the sale of equity shares have been made taxable. In the case of equity, long-term refers to the holding period of more than a year from the date of purchasing. Simply put, long term capital gains are the profits that are earned on the sale of equity shares.
Before 2018, investors could save tax on the LTCG earned on the sale of equity shares under the then prevalent Indian tax system. The idea behind keeping LTCG tax free was to increase investor participation in the equity markets. Thanks to the exemption, the investors began viewing equities as a favourable investment, as is evident from the growth of mutual fund portfolios from 1.37 crores to 6.65 crores in 2017.
Before we delve deeper into the long term capital gains tax under the Indian tax system, let us understand what LTCG is and how it will impact the tax saving and investments.
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Long Term Capital Gains is an asset held for more than 36 months. The reduced period of 24 months will not apply to the movable property assets such as debt oriented mutual funds and jewellery. They will only be classified as long term capital assets if they are held for 36 months.
The following assets, when held for more than a period of 12 months, will be considered as a long-term capital asset:
a) Units of UTI
b) Equity oriented mutual fund
c) Preference shares or equity in a company that is listed on a recognized stock exchange in India
d) Securities such as government securities, bonds, and debentures
e) Zero-coupon bonds
The long term capital gain tax applies to all the profits from the sale of assets, including equity, mutual funds, property, and gold. The assets should be helpful for more than one year from the date of purchase.
Considering that the tax applicable on equity and mutual funds as short term capital gain assets is at 15%, the long term capital gain tax is geared at promoting long term investments. This, in turn, encourages you to hold on to your securities for a more extended period.
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As per Budget 2020, the financial experts maintain you should not pay too much attention to the introduction or rollback of long term capital gain tax beyond a certain point. For investment purposes, it is always better to focus on the goals and risks when you are choosing mutual funds in your financial portfolio.
However, the proposal of long term capital gains tax on equity funds will affect the returns as they will be lower than expected. This could change the way you have been investing your savings so far.
For instance, the equity-linked savings scheme (ELSS) could lose the tax-free status and also its importance amongst investors who viewed it as a tax saving option under the Indian tax system.
At the same time, equity funds will also be exempted from the indexation benefit, increasing the disparity between equity and debt schemes, making the latter more attractive for investors.
At the same time, long term capital gains tax of 10% is applicable on equity shares of more than Rs. 1 lakh, that too without the benefit of indexation, as per Budget 2020.
However, don’t let the long term capital gains tax affect your investment decision just yet as the capital gains earned before 31 January 2018 will continue to remain tax-free.
It is also important to note that as per the new budget, a dividend distribution tax (DDT) of 10% has been proposed on equity mutual funds. While the dividend will continue to remain tax-free, the return on equity funds will reduce.
1. The long term capital gain tax makes options such as public provident fund and Unit Linked Insurance Plans more attractive than ELSS funds as tax saving instruments. These options will continue to be tax-free, while the ELSS fund will be taxed at 10%.
According to mutual fund managers, ELSS funds offer superior returns in the long run than other asset classes over a long period. Thus, they continue to be your best option when it comes to creating a corpus of funds to meet long-term financial goals. Their post-tax returns are still higher than PPF and ULIPs, making them a lucrative investment option.
Low-cost ULIPs are available online directly by insurance providers such as Max Life Insurance that provide returns similar to ELSS over a while.
ELSS funds are still a good investment option as far as tax-saving benefits of Income Tax Section 80C are concerned. Besides, they have the shortest lock-in period of three years among all the instruments under Income tax section 80C basket.
Following the 2020 budget announcement, mutual funds come highly recommended by financial advisors for their higher taxable returns than the low-performing tax-free assets.
In the end, financial experts advise that you should always include inflation and taxes when you are determining your target corpus to achieve long-term goals. However, mutual fund advisors believe that budget 2020 will adversely affect the popularity of Equity Linked Savings Scheme and make tax saving mutual funds more preferable.