The incumbent government in their latest budget has introduced the long-term capital gains (LTCG) tax on assets in the capital markets. The rate applicable is 10% on gains of Rs. 1 Lakh and higher. It shall apply to investments in listed equity shares and equity mutual fund units.
The introduction of this tax will affect mainly corporates and individuals. They account for 93% of the total Long-term capital gains tax reported by the Income-tax department.
What does this mean for investors in Mutual Funds?
– If you redeem your equity MF units, held for more than one year, before March 31, 2018, the tax rate applicable on LTCG shall be zero. As such, the new LTCG tax is effective for transactions done after March 31, 2018.
– LTCG on equity mutual fund units redeemed after March 31, 2018 will be exempt from tax up to Rs. 1 lakh per annum.
– All the gains up to January 31, 2018 will be grandfathered. For example, if a unit of mutual fund was purchased at NAV of Rs. 100 on June 1, 2017 and the NAV of the fund as on January 31, 2018 is Rs.125 and the units are redeemed on August 1, 2018 at NAV of Rs. 140, the total LTCG is Rs. 40, out of which Rs. 25 will be exempted. And balance LTCG of Rs. 15 will be taxable at 10%.
As a corollary, any units of an equity mutual fund purchased after January 31, 2018 are fully liable for LTCG tax at 10%.
A short summary of the tax applicable on mutual funds with regard to redemption and income is as under:
|Fund Type||Long term after||Long term gains taxed at||Short term gains taxed at||Dividends taxed at|
|Equity funds (including ELSS)||1 year||10% with no indexation||15%||10%|
|Debt funds||3 years||20% after indexation||Personal tax rate||25%|
|Liquid funds||3 years||20% after indexation||Personal tax rate||25%|
|Arbitrage funds||1 year||10% with no indexation||15%||10%|
|Balanced funds||1 year||10% with no indexation||15%||10%|
|Monthly income plan||3 years||20% after indexation||Personal tax rate||25%|
Is the tax justified by the government?
India has been relatively liberal with their LTCG tax policy on securities compared to almost all the other major nations.
Capital Gains Tax on Equities across major countries
|Country||STCG||LTCG||Holding period for LTCG|
|USA||As per slab||20%*||1 year|
|UK||N/A||28%**||No distinction with LTCG|
|Australia||As per slab||As per slab||Same as income tax|
|Canada||As per slab||As per slab^^||N/A|
*For the highest tax slab. Taxes go from 0% to 20% depending on the tax slab.
^With gains up to 31st January 2018, grandfathered
**For highest slab. Capital gains allowance of GBP 11,300 given.
^^50% of gain exempted.
Countries that have zero tax on capital gains tend to be those that specifically set out to use it to attract FIIs, for example, Singapore, as well as other tax havens. Back in 2005, India’s zero-rating of such tax could also be seen as a tactical move to attract FII investments. However, India’s growth story amongst the emerging markets is attractive enough for FIIs for investing.
However, the tax is inequitable in that assets held for 2 years or 20 years are taxed at the rate of 10% without taking into account the effect of inflation. It is essential that government should allow benefits of indexation for LTCG.
Being an investor in the Indian equities, it is not advisable to abandon the equity markets merely due to a reintroduction of a tax on LTCG. The return expectations of the equity markets will not change considerably enough for an investor to change asset allocations to another asset class, i.e. FDs, real estate.
An investor may be able to plan and take advantage of the basic Rs. 1 Lakh exemption to reduce the tax outgo.
It is important to only take on as much risk as you are comfortable with. It would be advisable to consult your independent financial advisor to seek the best course of action.