Long-Term Capital Gain (LTCG) Tax on Mutual Funds

People invest their hard-earned money in mutual funds to reach their financial objectives. The assets held by mutual funds generally increase in value over time, but this is not a surety. However, investors must pay taxes on the profits these investments have generated. In this blog post, we’ll discuss the idea of taxes on long-term capital gains on mutual funds.

What is LTCG Tax?

“Long-Term Capital Gain” (LTCG) is the name of the tax applied to the gains made when selling specific assets after a set amount of time. To put it simply, the government taxes gains earned on an asset known as a long-term capital gain when an investor sells it after holding it for a specific amount of time.

Features of LTCG tax on Mutual Funds

Long-term capital gains taxes have the following features:

1. LTCG is levied when an investor sells an asset after holding it for a certain period.
2. The rate of tax depends on the asset class.
3. The government provides certain exemptions if capital gain arises in some asset classes.
4. This is chargeable under the head Capital Gain of Income Tax Act.

LTCG on Mutual Funds

Mutual funds come in various forms according to asset classes, and depending on how long you keep the assets, you may have to pay long-term capital gain tax on them. 

Equity Mutual Fund

Mutual funds classified as equity funds invest primarily in equity-related securities; the holding duration determines how these funds are taxed. The gain will be referred to as a long-term capital gain if the holding period exceeds 365 days. Equity mutual funds are suitable for investors willing to assume additional risks in exchange for a higher return.

Taxation on Equity Mutual Fund

As per the Income Tax Act, the long-term gains made on equity mutual funds are taxed at 10% over and above 1 lakh. Let us understand this with an example.

On January 1, 2022, an individual invested INR 1 lakh in an equity-oriented mutual fund. On February 25, 2023, he sold it for INR 2.5 lakh, realizing a gain of INR 1.5 lakh due to bullish market conditions.

The investor will not pay taxes on the INR 1 lakh, while the remaining INR 50,000 will be subject to 10% tax. The total amount to be paid as taxes is INR 5,000. 

Debt Mutual Fund

Mutual funds that invest your money in fixed-income instruments like corporate bonds, government bonds, debentures, etc., are known as debt mutual funds. Debt funds, which offer lower returns than equities mutual funds, are a good option for investors not ready to take on a lot of risk. A mutual fund falls under the category of debt mutual fund if it invests less than 35% in equity.

Taxation on Debt Mutual Fund

In the past, gains on debt funds held for longer than three years were regarded as long-term and were subject to indexation. Gains realized on these funds before the three-year time frame are classified as short-term capital gains and are subject to taxation as per the individual’s tax slab rate. However, under the current law, profits on these funds are taxed according to your income tax slab, which varies from 10% to 30% depending on your income tax bracket, regardless of the holding term. 

If an individual is subject to a 30% tax bracket, invested INR 1 Lakh in a debt-oriented mutual fund on January 1, 2021, and sold it on June 10, 2024, but did so after three years and realized a profit of INR 50,000, he will be liable to pay taxes based on his 30% income tax slab, which means his total tax liability will be approximately INR 15,000.  

Hybrid Mutual Fund

The portfolios of hybrid mutual funds are allocated to debt and equity. Like equities and debt funds, the taxation of hybrid funds is contingent upon the holding duration and the portfolio’s asset allocation. 

Equity-Oriented Hybrid Funds  

The fund will be classified as an equity-oriented hybrid fund if at least 65% of its total assets are allocated to equities and equity-related securities. The gains from equity-oriented hybrid funds are subject to a 10% tax on profits exceeding one lakh Indian rupees upon sale after one year. 

Debt-Oriented Hybrid Funds 

A mutual fund is classified as debt-oriented if it has an equity exposure between 35% and 64%. The gains realized after 36 months will be considered long-term gains and taxed at 20% with indexation benefits.

For example, if an individual invested INR 1,00,000 in a fund with approximately 60% of its total allocation in debt and the remaining 40% in equity, the fund will be regarded as a debt-oriented hybrid fund. The investor redeemed his investment for INR 1,50,000 and realized a gain of INR 50,000 after four years. 

Purchase value after indexation = Original Amount * ( Current year CII / Purchasing year CII) 

Here, CII = Cost Inflation Index

Let the CII in the purchase year be 102 and the CII in the current year be 110

Purchase value after indexation = INR 1,00,000 * (110/102) = INR 1,07,843

Total realized gain with indexation benefit = INR 1,50,000 – INR 1,07,843 = INR 42,157

Tax Payable = 20% * INR 42,157 = INR 8,431 

Exemptions on Capital Gains

Apart from the INR 1,00,000 exemption on equity mutual funds, an investor can also claim the following exemptions:

Section 10(38)

Under this section, the long-term capital gains resulting from the transfer of equity and equity-oriented mutual funds are exempt from taxes if the following conditions are met:

• Transfer should be after October 1, 2004.
• It should be a long-term asset.
• Security transaction taxes are applicable.

Section 54F

The section 54F allows investors to save capital gains taxes if the proceeds of the sale of a long-term capital asset are used to buy or construct a residential house in India. The tax exemption can be claimed if:

• The property must be purchased one year before or two years after the sale of mutual funds.
• The property must be constructed within three years from the sale of mutual funds.

Conclusion

To sum up, an investor must be aware of the taxes applicable to the gains realized by their mutual fund investments. A long-term investment horizon has more tax benefits compared to investing for a short time. However, the investment horizon is determined by the individual’s financial conditions, so you should speak with your investment advisor before making decisions. 

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