The Finance Bill 2023 has removed long-term capital gains tax benefits on certain mutual funds with effect from April 1, 2023. Here's an explanation of what that entails.
What is Capital Gains tax?
The Income Tax department categorises all sources of income under 5 heads:
- Salary
- House Property
- Profits and Gains from business/profession
- Capital Gains
- Other Sources
What is capital gain?
When you make a profit by selling an asset, it is known as a capital gain (difference between the purchase price and the sale price). Gold, jewellery, fixed-income instruments, stocks, mutual funds, real estate, paintings, sculptures, cars are examples of assets.
This is further divided into short-term capital gains (STCG) and long-term capital gains (LTCG).
What is STCG & LTCG?
Depends on the period of holding.
Generally, if you sell your asset before the completion of 36 months of holding, the gain is treated as STCG. If you sell your asset after the completion of 36 months of holding, the gain is treated as LTCG.
In these instances, the period of holding to be considered is 12 months instead of 36 months. If you sell after 12 months, it is considered as LTCG.
- Shares, equity mutual funds (minimum 65% of the portfolio is in equity shares of domestic companies), listed securities like debentures and Government Securities, units of UTI and zero-coupon bonds.
In these instances, the period of holding to be considered as 24 months instead of 36 months. If you sell after 24 months, it is considered as LTCG.
- Unlisted shares of a company, immovable property (land or building).
For example, let us say Kapil and Anita purchased gold in April 2019. Kapil sold it in December 2020. Anita sold it in December 2022. In both cases, gold was a capital asset for each. But for Kapil, it will be treated as a short-term capital asset (he held it for a period of less than 36 months). For Anita, it will be treated as a long-term capital asset (she held it for a period of more than 36 months).
What is the tax rate?
The taxability of capital gains depends on the nature of gain, i.e., whether short-term or long-term. The tax rates for long-term capital gain and short-term capital gain are different.
STCG tax on stocks and equity mutual funds is 15%.
There was no LTCG tax on equity until the Union Budget 2018 introduced a flat 10% tax on stocks and equity mutual funds. This is a flat tax with no indexation benefit. There is one basic annual exemption limit – Rs 1 lakh. So the tax is 10% on gains in excess of Rs 1 lakh per annum.
Non-equity investments are taxed as per the income tax slab rate of the investor. Which means that if your tax rate is 30%, STCG tax is 30%.
LTCG tax for non-equity investments is 20% with indexation. This has changed.
From April 1, 2023 (FY23-24 onwards), capital gains from debt mutual funds will get added to their income and the relevant tax slab rate will be applicable, irrespective of their holding period.
Gold ETFs, Gold FoFs, FoFs and global funds fall into the debt fund category for taxation purposes (to qualify as equity, a minimum 65% of the portfolio must be in equity shares of domestic companies). This means, similar to debt mutual funds, there will be no indexation benefit available for investors for their long-term investments.
All the above mentioned tax rates exclude cess and surcharge / ETF: Exchange Traded Fund / FoF: Fund of Funds
What must investors do?
The above change in only applicable from investments made in the next financial year starting April 1, 2023. Investments made till March 31, 2023, will continue to attract long-term capital gains taxation once they complete 3 years.
Hence there seems to be a rush to put in money in debt funds before the year ends.
Please remember that taxation is just one aspect of the investment process and should not be the sole driver of where money needs to be allocated.
When constructing a portfolio, you need to look at your risk appetite, period for which you want the money invested, diversification and asset allocation.
When it comes to a specific product, you need to consider returns, liquidity, transparency and how it fits in with your overall portfolio.
Do not rush to make ad-hoc decisions and misallocate your money.
