Understanding Capital Gains Tax on Equity and Mutual Funds

Capital Gains Tax

Investing in equity and mutual funds can significantly enhance your wealth but also entails tax obligations on capital gains. Capital gains tax is levied on the profit earned from selling investments like equity shares or mutual funds at a higher price than their purchase cost. Understanding how these taxes work is essential for investors to manage their financial portfolios effectively and optimize returns. This blog aims to demystify capital gains taxation on equity and mutual funds, providing you with the knowledge needed for informed financial decisions.

What is a Capital Gain?

Capital gain refers to the profit realized when an investment is sold for a higher price than its purchase cost. Here’s how it applies to equity and mutual funds:

1. Capital Gain on Equity:

  • Definition: This refers to the increase in the value of stocks or shares held by an investor. It occurs when the selling price of the stock exceeds its purchase price.
  • Types:
    • Short-Term Capital Gain (STCG): Realized when shares are sold after being held for one year or less. Short-term gains are typically taxed at higher rates than long-term gains.
    • Long-Term Capital Gain (LTCG): Realized from the sale of shares held for more than one year. Long-term gains often benefit from lower tax rates compared to short-term gains.

2. Capital Gain on Mutual Funds:

  • Definition: This refers to the increase in the value of mutual fund units owned by an investor. It is typically realized when the fund manager sells securities within the fund for a profit.
  • Types:
    • Short-Term Capital Gain (STCG): Occurs when mutual fund units are sold within a year of purchase (equity-oriented mutual funds). The short-term capital gains tax rate is generally higher than that for long-term gains.
    • Long-Term Capital Gain (LTCG): Arises when mutual fund units are sold after being held for more than one year (equity-oriented mutual funds). Long-term capital gains on mutual funds may qualify for lower tax rates compared to short-term gains.
Capital Gains Tax

Tax Applicability on Capital Gains from Mutual Funds

The tax rates on capital gains from mutual funds in India vary based on the type of mutual fund and the holding period. Here’s a breakdown of the current rates:

Equity-Oriented Mutual Funds:

  • Short-Term Capital Gains (STCG): If the holding period is less than 12 months, the gains are taxed at 15%.
  • Long-Term Capital Gains (LTCG): If the holding period is more than 12 months, gains up to ₹1 lakh in a financial year are tax-exempt. Gains exceeding ₹1 lakh are taxed at 10% without the benefit of indexation.

Debt-Oriented Mutual Funds:

  • Short-Term Capital Gains (STCG): If the holding period is less than 36 months, the gains are taxed at the individual’s applicable income tax slab rates.
  • Long-Term Capital Gains (LTCG): If the holding period is more than 36 months, the gains are taxed at 20% with the benefit of indexation.

Hybrid Mutual Funds:

  • Equity-Oriented Hybrid Funds: Treated like equity-oriented mutual funds, the same STCG and LTCG rules apply.
  • Debt-Oriented Hybrid Funds: Treated like debt-oriented mutual funds, the same STCG and LTCG rules apply.

Dividends from Mutual Funds:

  • Dividends obtained from a mutual fund were tax-free in the hands of investors until 31 March 2020. However, starting 1 April 2020, dividends are taxable in the hands of investors as the Dividend Distribution Tax (DDT) was abolished. A TDS at the standard rate of 10% is imposed on dividend income paid in excess of Rs 5,000 from a company or mutual fund.

Tax Applicability on Capital Gains from Equity Shares

The tax rates on capital gains from equity shares in India depend on the holding period of the shares. Here’s a detailed breakdown:

Short-Term Capital Gains (STCG):

  • Holding Period: Less than 12 months.
  • Tax Rate: 15%.
  • Conditions: This rate applies if the securities transaction tax (STT) is paid on the sale transaction.

Long-Term Capital Gains (LTCG):

    • Holding Period: More than 12 months.
    • Tax Rate: 10% (without the benefit of indexation).
    • Exemption: Gains up to ₹1 lakh in a financial year are tax-exempt. Gains exceeding ₹1 lakh are taxed at 10%.
    • Conditions: This rate applies if the STT is paid on the purchase and sale of the equity shares.

Dividends from Equity Shares:

  • From the fiscal year 2020-21, dividends from equity shares are taxed in the hands of the shareholders at their applicable income tax slab rates, as the earlier Dividend Distribution Tax (DDT) was abolished.

Surcharge and Cess:

  • A surcharge may apply depending on the total income, and a Health and Education Cess at the rate of 4% is levied on the tax payable.
Capital Gains Tax

Strategies to Save on LTCG from Equity-Oriented Funds

  • Offsetting Gains with Losses: You can offset capital gains from equity-oriented funds against any capital loss incurred on the sale of these funds. However, a long-term capital loss can only be set off against long-term capital gains. If you cannot adjust your capital losses in the same year, you are allowed to carry them forward for the next eight years. You can set off these losses against your capital gains in the following years. However, you must file your ITR and show these losses even when you don’t have any income.
  • Section 54F: This section allows individuals to benefit from a long-term capital gain tax exemption on shares, provided they fulfill certain requirements.

Read More: How to Check Income Tax Refund Status for 2023-24

Investing in stocks and mutual funds can significantly increase wealth, but it also entails capital gains tax responsibilities. Understanding how these taxes work is essential for effectively managing your financial portfolio and maximizing returns. By being aware of the different tax rates and regulations for short-term and long-term capital gains, as well as the potential benefits of indexation, investors can make informed financial decisions and strategically plan their investments to minimize tax liabilities. Staying up to date on the most recent legislation or consulting a tax adviser is advisable to navigate these complexities effectively.

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