The Union Budget 2024, presented in July, introduced significant changes to tax rules for mutual fund investments, affecting both short-term and long-term capital gains. Investors selling mutual fund units within a year will now face a higher tax rate on their profits. For those holding investments for over a year, the tax on long-term capital gains has seen a slight increase. However, small investors will benefit from an increased tax-free limit on long-term capital gains, now set at Rs 1.25 lakh.
Taxation on mutual funds in India varies based on the type of mutual fund (equity or debt) and the duration for which the investment is held. Each type of mutual fund has different rules for calculating capital gains and tax liabilities. For example, equity and debt mutual funds have distinct holding periods that determine whether the gains are classified as short-term or long-term, with varying tax rates applicable to each.
Understanding these distinctions is crucial for investors aiming to maximize returns while minimizing their tax burden. Below are the tax implications for various types of mutual funds:
Income Tax Implications on Equity Mutual Funds
- Short-Term Capital Gains (STCG): Gains from the sale of equity mutual fund units held for less than 12 months are categorized as Short-Term Capital Gains (STCG). These gains will be taxed at 20% for transfers occurring on or after July 23, 2024, and at 15% for transfers made before this date.
- Long-Term Capital Gains (LTCG): Gains from the sale of equity mutual fund units held for over 12 months are classified as Long-Term Capital Gains (LTCG). For gains exceeding Rs 1.25 lakh in a financial year, a tax of 10% applies to those realized before July 23, 2024, and 12.5% for gains realized on or after this date. Investors will need to strategize their LTCG to remain within the Rs 1.25 lakh exemption, encouraging smaller investors to invest more for tax-free gains. Furthermore, the increase in STCG tax from 15% to 20% for listed shares may prompt investors to consider long-term trading strategies for their investments.
Equity mutual funds, as defined by the Income Tax Act of 1961, allocate at least 65% of their assets to the equity shares of domestic companies.
Income Tax Implications on Debt Mutual Funds
Taxation of Debt Mutual Funds Before April 1, 2023:
Previously, the taxation of debt mutual funds was governed by holding period rules:
- Short-Term Capital Gains (STCG): If debt mutual fund units were sold within 36 months (three years) of purchase, the gains were classified as short-term capital gains (STCG) and taxed at slab rates.
- Long-Term Capital Gains (LTCG): If sold after 36 months, the gains were considered long-term capital gains (LTCG) and taxed at 20%, with the benefit of indexation, which adjusts gains for inflation.
Taxation of Debt Mutual Funds On or After April 1, 2023:
From April 1, 2023, debt mutual funds are taxed at the taxpayer’s applicable slab rates, regardless of the holding period. This change has adversely affected debt mutual fund investors by increasing their tax liability.
According to the Income Tax Act of 1961, debt mutual funds allocate less than 65% of their assets to equity shares of domestic companies.