Long-Term Capital Gain (LTCG) Taxation on Mutual Funds in India: A Comprehensive Guide

Unless you are a tax expert yourself, understanding the nuances of different kinds of taxation can be quite cumbersome. Tax laws keep changing to keep up with the demands of the economy, and as such it is important to stay in the loop about how you, the person who pays the taxes, is affected. 

As an investor, it is important to understand how and where to invest so that you can save taxes while also building wealth. It’s your hard-earned money after all! 

If you have been investing in mutual funds for some time now, or are just getting started, you might especially want to understand how long-term capital gain taxes work. Do not worry; it’s not that complicated. 

By the end of this blog post, you’ll be an expert at understanding these taxes and making investment decisions that promise potential high returns. Let’s get started.

What is Long-Term Capital Gain Tax on Mutual Funds?

Long-term capital gains (LTCG) on mutual funds arise when you sell your mutual fund units at a profit after holding them for more than a year. The tax treatment for LTCG on mutual funds depends on the type of mutual fund, namely Equity Funds and Debt Funds.

How Does Long-Term Capital Gains on Mutual Funds Work?

“Long-term capital gains” is a mouthful, isn’t it? Let’s just stick to LTCG for our discussion. Makes life easier. Anyway, moving on!

LTCG tax applies to the profits you generate when you sell your mutual fund units after holding them for more than one year. In simpler terms, it's the tax levied on the capital gains that exceed the original investment amount, provided you've held the units for over a year.

There are two main categories of mutual funds to consider when it comes to LTCG tax:

•    Equity Funds: These funds invest a majority of their assets (over 65%) in company stocks.
•    Debt Funds: These funds invest primarily in fixed-income instruments like bonds and government securities.

The LTCG tax treatment differs for these two categories. Let’s understand them in detail now.

Equity Funds and LTCG Taxes

Equity funds invest in stocks of various companies. They can be broadly categorized into tax-saving and non-tax-saving options.

•    Equity Linked Saving Schemes (ELSS): These tax-saving equity funds come with a mandatory lock-in period of 3 years. Since you cannot redeem your investment before this period, any capital gains qualify as LTCG.

•    Non-Tax Saving Equity Funds: Unlike ELSS, these funds have no lock-in period. Consequently, they can incur both LTCG and Short-Term Capital Gain (STCG) tax depending on the holding period. LTCG tax applies at a flat rate of 10% on gains exceeding Rs. 1 lakh in a financial year, without indexation benefit.

We also have LTCG tax on equity-oriented hybrid funds. These funds invest in a combination of equity and debt instruments. As long as at least 65% of the fund's assets are in equity or equity-oriented shares, the LTCG tax treatment is similar to equity funds (10% without indexation).

Debt Funds and LTCG Taxes

Debt funds primarily invest in fixed-income instruments like bonds and government securities. Debt funds invest primarily in fixed-income instruments like bonds and government securities. The taxation of gains from these funds has changed since April 2023:

•    All gains are now treated as Short-Term Capital Gains (STCG): Previously, debt funds held for more than 3 years enjoyed Long-Term Capital Gains (LTCG) benefits. However, under the current rules, the holding period doesn't matter. Any capital gains from debt funds, irrespective of how long you hold them, are classified as STCG.

•    Taxed at your income tax slab rate: STCG from debt funds are added to your taxable income and taxed at the marginal income tax rate applicable to you. This can range from 10% to 30% depending on your income bracket.

How to Reduce Long-Term Capital Gains Tax on Mutual Fund Returns

While LTCG tax is an inevitable aspect of profiting from mutual funds, there are strategies to potentially minimize its impact:

•    Tax-Efficient Investing: Consider investing in tax-saving mutual funds like ELSS (Equity Linked Saving Schemes) that offer tax deductions on investments up to Rs. 1.5 lakh per year under Section 80C of the Income Tax Act.

•    Tax Loss Harvesting: This strategy involves selling mutual funds that are in a loss to offset capital gains from other funds. These losses can be used to reduce your overall taxable capital gains, potentially lowering your tax liability.

•    Invest for the Long Term: Generally, the longer you hold your mutual fund units, the more likely you are to benefit from long-term capital appreciation. This can help you stay within the Rs. 1 lakh exemption limit for equity LTCG tax.

Always remember to consult a tax advisor is essential before implementing any tax-saving strategies.

Comparing the Long-Term Capital Gains Tax Situation on Different Mutual Funds

Yes, we have already discussed how different equity and debt funds are taxed on long-term capital gains. But here’s a table that breaks down the information into bite-sized pieces for better understanding:

Type of Fund	Updated Tax Rate (From April 2023)
Equity Funds and Equity-Oriented Hybrid Funds	Any gains above Rs. 1 lakh are taxed at 10% + cess + surcharge
Debt Funds and Debt-Oriented Balanced Funds	Investor’s income tax slab rate

Conclusion

Understanding taxation on mutual funds can seem challenging. And we won’t mince our words: to some extent, it really is. However, that doesn’t mean it’s impossible to wrap our heads around the rules. All it takes is a little bit of awareness and staying in loop with the updated tax policies. 

Also, it is always wise to consult reputed fund houses like Shriram AMC, or skilled tax experts who can guide you through the often-complicated topic of taxation, and help you make healthy investment decisions.

FAQs

Here are a few frequently asked questions about taxes on long-term capital gains on mutual funds in India:

1.    Are there any mutual funds that are completely tax free in India?

As per the latest tax updated of April 2023, all mutual funds attract short-term as well as long-term capital gains taxes.

2.    Should I pay mutual fund taxes every year?

No, you only pay tax on capital gains (LTCG) when you redeem your units. However, your dividend income is taxed annually if your total income necessitates it.

3.    What else should I consider besides tax benefits when choosing tax-saving mutual funds?

Look beyond tax savings! Evaluate factors like your investment style (SIP or lump sum), risk tolerance (asset allocation), and investment horizon (lock-in period) to pick an ELSS fund that aligns with your overall financial goals.

4.    Does Section 54EA still offer tax benefits for capital gains?

No, Section 54EA, introduced before 2000, is no longer applicable for current capital gains tax exemptions. The current provisions for LTCG tax benefits are outlined in Sections 54EC and 54EE.