Investing in equity and mutual funds not only offers the potential for wealth accumulation but also triggers tax obligations on capital gains. Capital gains tax is levied on the profit earned from selling investments like equity shares or mutual funds at a higher price than their purchase cost. Understanding how these taxes work is essential for investors to effectively manage their financial portfolios and optimize returns. This introduction aims to explore the intricate world of capital gains taxation in equity and mutual funds. Whether you’re planning your investment strategy or navigating the complexities of tax planning, having a clear grasp of how capital gains are taxed can empower you to make informed financial decisions.
What do you mean by Capital gain?
Capital gain on equity and mutual funds refers to the profit earned when these assets are sold at a higher price than their purchase cost. Here’s a breakdown:
1. Capital Gain on Equity:
- Definition: Capital gain in equity refers to the increase in the value of stocks or shares held by an investor. It occurs when the selling price of the stock exceeds its purchase price.
- Types:
- Short-Term Capital Gain: This is realized when shares are sold after being held for one year or less. In many countries, short-term capital gains are taxed at higher rates than long-term gains.
- Long-Term Capital Gain: Refers to gains realized from the sale of shares held for more than one year (the exact period can vary by jurisdiction). Long-term capital gains often benefit from lower tax rates compared to short-term gains.
2. Capital Gain on Mutual Funds:
- Definition: Capital gain in mutual funds refers to the increase in the value of mutual fund units owned by an investor. It is typically realized when the fund manager sells securities within the fund for a profit.
- Types:
- Short-Term Capital Gain: Occurs when mutual fund units are sold within a year of purchase (equity oriented mutual funds). The short-term capital gains tax rate is generally higher than that for long-term gains.
- Long-Term Capital Gain: Arises when mutual fund units are sold after being held for more than one year (Equity oriented mutual fund). Long-term capital gains on mutual funds may qualify for lower tax rates compared to short-term gains.
Tax applicability on Capital gain on Mutual Funds -:
The tax rates on capital gains from mutual funds in India vary based on the type of mutual fund and the holding period. Here’s a breakdown of the current rates:
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Equity-Oriented Mutual Funds
- Short-Term Capital Gains (STCG): If the holding period is less than 12 months, the gains are considered short-term and taxed at 15%.
- Long-Term Capital Gains (LTCG): If the holding period is more than 12 months, the gains are considered long-term. Gains up to ₹1 lakh in a financial year are tax-exempt. Gains exceeding ₹1 lakh are taxed at 10% without the benefit of indexation.
Debt-Oriented Mutual Funds
- Short-Term Capital Gains (STCG): If the holding period is less than 36 months, the gains are considered short-term and taxed at the individual’s applicable income tax slab rates.
- Long-Term Capital Gains (LTCG): If the holding period is more than 36 months, the gains are considered long-term and taxed at 20% with the benefit of indexation.
Hybrid Mutual Funds
- Equity-Oriented Hybrid Funds: Treated like equity-oriented mutual funds, the same STCG and LTCG rules apply.
- Debt-Oriented Hybrid Funds: Treated like debt-oriented mutual funds, the same STCG and LTCG rules apply.
Dividends from Mutual Funds
Dividends obtained from a mutual fund was tax-free in the hands of investors until 31 March 2020 (FY 2019-20). That was because the company declaring dividends paid dividend distribution tax (DDT) before making the dividend payment. However, the Finance Act, 2020 changed the method of dividend taxation.
All dividends received on or after 1 April 2020 will be taxable in the hands of the investors as the DDT on dividends was withdrawn. The Finance Act, 2020 also imposes a TDS on dividend distribution by mutual funds on or after 1 April 2020. The standard rate of TDS is 10% on dividend income paid in excess of Rs 5,000 from a company or mutual fund.
Note: These rates are subject to change based on updates in tax laws, so it’s essential to check the latest guidelines or consult a tax advisor for current information.
Tax applicability on Capital Gain on Equity Shares -:
The tax rates on capital gains from equity shares in India depend on the holding period of the shares. Here’s a detailed breakdown:
Short-Term Capital Gains (STCG)
- Holding Period: Less than 12 months
- Tax Rate: 15%
- Additional Conditions: This rate is applicable if the securities transaction tax (STT) is paid on the sale transaction.
Long-Term Capital Gains (LTCG)
- Holding Period: More than 12 months
- Tax Rate: 10% (without the benefit of indexation)
- Exemption: Gains up to ₹1 lakh in a financial year are tax-exempt. Gains exceeding ₹1 lakh are taxed at 10%.
- Additional Conditions: This rate is applicable if the STT is paid on the purchase and sale of the equity shares.
- As of the fiscal year 2020-21, dividends from equity shares are taxed in the hands of the shareholders at their applicable income tax slab rates. The earlier Dividend Distribution Tax (DDT) was abolished.
Surcharge and Cess
- A surcharge may apply depending on the total income, and a Health and Education Cess at the rate of 4% is levied on the tax payable.
Note: These Tax rules can vary, so it’s best to stay up to date on the most recent legislation or speak with a tax adviser about these rates.
Possible Ways to save LTCG on Equity oriented Funds?
- You can offset capital gains from equity-oriented funds against any capital loss incurred on the sale of these funds. However, a long-term capital loss can be set off only against long-term capital gains.
- If you cannot adjust your capital losses in the same year, you are allowed to carry them forward for the next eight years. You can set off these losses against your capital gains in the following years. However, you must file your ITR and show these losses even when you don’t have any income.
- Section 54F allows individuals to benefit from a long-term capital gain tax exemption on shares. They need to fulfill certain requirements in order to qualify for this provision.
Conclusion
If we had to summarize the entire article, the main point would be that while investing in stocks and mutual funds has the potential to significantly increase wealth, it also has capital gains tax responsibilities. Profits made by selling investments, such as stocks or mutual funds, for more money than they were originally purchased are subject to capital gains tax. Investors must comprehend how these taxes operate in order to efficiently manage their financial portfolios and maximize returns. By being aware of the different tax rates and regulations for short-term and long-term capital gains, as well as the potential benefits of indexation, investors can make informed financial decisions and strategically plan their investments to minimize tax liabilities.
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Authors: CA Prashant Taparia (Partner), CA Sohil Shah (Manager), and Vansh Shah (Associate Consultant) | Email: [email protected] | Contact: +91 98709 25375.
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