In Mutual Fund Investments, there are two types of gains that an investor can earn. The first one is earnings from Dividends & the second one is earnings from Capital Gain. In Capital Gain, there are two types w.r.t Income Tax Act.
- Short-Term Capital Gain
- Long-Term Capital Gain
In this blog, we are going to see how to measure the gain and what are the tax implications of Long-Term Capital Gain.
What is Capital Gain?
As per Wikipedia, the definition of Capital Gain is;
“Capital gain” is an economic concept defined as the profit earned on the sale of an asset that has increased in value over the holding period. An asset may include tangible property, a car, a business, or intangible property such as shares.
In the context of Mutual Funds, a capital gain is a profit earned by investors after selling the mutual fund units.
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Taxation of Long-Term Capital Gain:
Taxation on the capital gain depends on the holding period & Category of the Mutual Fund investment.
The criteria for Long-Term are different for the Equity Category and Debt category.
| Category | Equity | Debt | Hybrid (Equity Focused) | Hybrid (Debt Focused) |
| Long-Term | 12 Months & above | 36 Months & above | 12 Months & above | 36 Months & above |
That means if the investors hold Equity Mutual Fund Units for more than 12 months, the gains from that investments are considered Long-Term Gains and will be taxed accordingly.
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Long Term Capital Gain on Equity Category:
| Tax Rate | 10% + cess & surcharge
(without indexation) |
| Exempt Amount on Gains from Equity Category | Gains up to Rs. 1 Lac are tax-free. |
Example: (Amount in Rs.)
| Date of Purchase | 31.12.2020 | 01.01.2022 |
| No. of Units | 120 | 1000 |
| NAV at the time of Purchase | 70 | 70 |
| Total Purchase Price | Rs. 8,400/- | Rs. 70,000/- |
| Date of Redemption | 31.07.2022 | 31.07.2022 |
| NAV at the time of Redemption | 200 | 200 |
| Total Selling Price | Rs. 24,000/- | Rs. 2,00,000/- |
| Total Profit | Rs. 15,600/- | Rs. 1,30,000/- |
| Profit above Rs. 1 Lac | — | Rs. 30,000/- |
| Tax Rate | — | 10% |
| Long Term Capital Gain | Nil | Rs. 3,000/- |
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Long Term Capital Gains on Debt Category:
| Tax Rae | 20% with indexation benefit |
What is Indexation?
Section 48 of the Indian Income Tax Act, 1961, defines the indexation as notified by the government every year. Cost Inflation Index is a measure of inflation, used to calculate long-term capital gains from the sale of capital assets.
In simple terms, indexation is a process through which the cost of purchase of an asset can be adjusted or inflated, or increased over a period of time to bring it to existing prices after considering the inflation factor.
Indexation benefit allows the investor to increase the price of the purchase of the asset so that profit would be less and so will the tax.
Example: (Amount in Rs.)
| Date of Purchase | 01.07.2017 |
| No. of Units | 1000 |
| NAV at the time of Purchase | 250 |
| Total Purchase Price | Rs. 2,50,000/- |
| Date of Redemption | 01.03.2021 |
| NAV at the time of Redemption | 300 |
| Total Selling Price | Rs. 3,00,000/- |
| Total Profit | 50000 |
| Indexed Cost of Purchase | Rs. 2,76,654/- |
| Total Profit after Indexation
(300000-276654) |
Rs. 23,346/- |
| Tax Rate | 20% |
| Long-Term Capital Gain | Rs. 4,669/- |
Indexed Cost of Acquisition= Original cost of acquisition * (CII of the year of sale/CII of year of purchase) = 250000*301/272 = 276654
So, instead of paying 20% tax on Rs. 50,000/-, investors will pay a tax of Rs. 23,346/-.
This is possible due to the indexation benefit.
As compared to the other Debt Category products such as Bank FD, Debt Mutual Fund is Tax-Efficient in the Long-Term due to indexation benefits.
So what are you waiting for? If you want to invest in the Debt Category for the long-term, you can opt for Debt Category Mutual Funds or Hybrid (Debt Focused) Mutual Funds.
This way you can earn slightly better returns in a tax-efficient manner.
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