All You Need to Know About Capital Gain Tax on Your Mutual Funds

• "In this world, nothing is certain but death and taxes." - Benjamin Franklin

Mutual funds over the years have generated wealth for their investors. If you have booked profits, i.e. earned capital gains - whether short term or long term - there will be a tax impact.

This tax impact depends on the type of mutual fund - equity-oriented, debt-oriented, or other.

Read on...

Equity Mutual Funds

These are schemes investing a minimum of 65% of their assets in equity and equity-related instruments.

Short Term Capital Gains

If the units sold in an equity-oriented scheme are within a holding period of less than 12 months, it will be considered as Short Term Capital Gain (STCG).

The STCG is taxed at a rate of 20% for resident individuals, with effect from 23 July 2024, i.e. the date of presentation of the full union budget 2024-25 by the Modi 3.0 government.

For transfer of units before 23 July 2024, i.e. between 1 April 2024 and 22 July 2024, the STCG shall be taxable at 15% (the earlier rate).

You see, the rate was increased by the government to discourage investors from engaging in speculative trading activity, which often results in higher volatility in the equity market.

If you are an NRI, tax deduction at source (TDS) on the STCG will be at 15% or 20%, as the case may be, on the sale or transfer of units.

Long Term Capital Gains

The gains on redemption of equity mutual funds where the holding period is more than 12 months will be classified as Long Term Capital Gains (LTCG).

For resident individuals, with effect from 23 July 2024, the LTCG will be taxed at 12.5%, for gains in excess of Rs 1.25 lakh in a financial year.

Earlier, the LTCG tax rate was 10% for equity funds and gains over Rs 1 lakh in a financial year were taxed.

If you have booked LTCG between 1 April 2024 and 22 July 2024, it will be taxed at 10% if greater than Rs 1 lakh.

For NRIs, there will be TDS on LTCG at 10% or 12.5%, as the case may be.

Debt Mutual Funds

These are schemes investing a predominant (65%) portion of their assets in debt & money market securities.

For resident individuals, the capital gains on redemption of debt funds purchased on or after 1 April 2023 are taxed at the marginal rate (i.e. as per the income tax slab rate applicable to investors) irrespective of the holding period.

The government, with effect from 1 April 2023, has removed the indexation benefit for debt mutual funds, which was applicable to long-term holdings. The government made no change in the union budget 2024-25 in this respect.

In other words, debt funds are now at par with bank fixed deposits (FDs) as regards the tax impact.

That said, keep in mind that LTCG tax on investments in debt mutual funds made on or before 31 March 2023, will still be taxed at 20% with indexation benefit.

These will be taxed at 12.5% without indexation if the units were redeemed on or after July 23, 2024. In this case, the holding period definition to classify long term is 24 months.

Long Term Capital Gain Tax for Debt Funds

Transaction type	Holding period	Capital gains tax
Debt funds purchased before 1 April 2023	More than 24 months	12.5% without indexation benefit
Debt funds purchased on or after 1 April 2023	NA	As per the investor's tax slab

For NRIs, the capital gains on debt mutual funds -- deemed to be STCG -- are subject to 30% TDS.

Other Mutual Funds

As regards the other mutual fund schemes, investing less than 65% of their assets in domestic equities and less than 65% in debt & money instruments, viz. balanced hybrid funds, multi asset allocation funds, gold mutual funds, etc., here the holding period to classify STCG and LTCG is different.

A holding period of 24 months or more is in these funds is considered as long term, and less than 24 months short term. This period earlier was 36 months.

Short Term Capital Gains

In case of other mutual funds, if you are a resident individual, with effect from 23 July 2024, the STCG will be taxed as per your applicable income-tax slab rate, whether the units were purchased on or before 31 March 2023 or after this date.

Long Term Capital Gains

For LTCG booked on other mutual funds, the tax rate is 12.5% without indexation benefit for transfer units on or after 23 July 2024.

For units sold before 23 July 2024, the LTCG will be subject to 20% tax with an indexation benefit (i.e. adjusting the cost of inflation index). This is because earlier, when the holding period of 36 months or more, the LTCG were taxed at 20% with indexation benefit.

A point to note here is that with the reduction in holding period for classification of STCG or LTCG, the tax outgo for you as a resident individual may be a bit high, particularly with the indexation benefit taken away with effect from 23 July 2024.

For NRIs, the STCG is subject to tax at 30% TDS, and LTCG at 20% or 12.5%, as the case may be.

What if There is a Capital Loss?

Well, the capital loss booked - whether short term or long term - may indirectly help you reduce the tax outgo.

The Income Tax Act, 1961, provides for set off and carry forward of capital gains against capital losses. Simply put, you can offset your capital gains against the capital loss.

Note, as per the rules, the capital loss can be set-off only against the head 'Income from Capital Gains'. The Long Term Capital Loss (LTCL) can be set off only against LTCG. Also, as per the current tax rule for FY25, LTCG is only taxable if it is over Rs 1.25 lakh in a financial year.

In contrast, the Short Term Capital Losses (STCL) are permitted to be set off against both LTCG and STCG.

You can also carry forward the capital losses, in case you are not able to set off the capital losses in the same assessment year (relevant to the respective financial year). The capital losses can be carried forward up to 8 years for both STCL as well as LTCL.

Conclusion

Both lump sum and SIP investments made in mutual funds are subject to capital gain tax. In case of SIP, the redemption is processed on a first-in, first-out (FIFO) basis, and accordingly the holding period is calculated.

But despite the tax impact, mutual funds are still a tax-efficient investment avenue.

Make sure you are paying taxes on time on the profits booked from mutual fund investments and abiding by the constitutional and moral duty.

Be a responsible and thoughtful investor.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a recommendation and should not be treated as such.