Union Budget: The full Budget 2024, which was presented in July, brought about significant alterations to the taxation regulations governing mutual fund investments. Mutual funds are a popular choice of investment. During 2024, the cash reserves of mutual funds rose by Rs 70,081 crore, reaching Rs 1.80 lakh from Rs 1.10 lakh at the beginning of the current calendar year by November.
The budget changes have an impact on both short-term and long-term capital gains. After July 2024, investors who sold mutual fund units within a year were subjected to a heightened tax rate on their profits. Additionally, individuals holding onto their investments for longer than a year will experience a slight increase in the tax levied on long-term capital gains.
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Nevertheless, small investors stand to benefit from an elevated tax-free threshold on long-term capital gains, now standing at Rs 1.25 lakh.
Taxation of mutual funds
The taxation of mutual funds in India is determined by the type of fund (equity or debt) and the length of time the investment is held. Each type of mutual fund is subject to specific rules for calculating capital gains and tax obligations. Equity and debt mutual funds have different holding periods which dictate whether the gains are deemed short-term or long-term, each with varying tax rates.
Change in taxation
In the 2024 Union Budget, Finance Minister Nirmala Sitharaman proposed several changes aimed at simplifying and rationalizing taxes for both listed and unlisted assets. A key change announced was an increase in the long-term capital gains (LTCG) tax on listed assets, particularly equity mutual funds. The LTCG tax on equity was first introduced in March 2018 and applies to the sale of assets held for the long term.
The LTCG tax on equity mutual funds was raised from 10% to 12.5%. Additionally, the exemption limit on certain financial assets has been raised from Rs 1 lakh to Rs 1.25 lakh per year.
Taxes on equity funds
According to the Income Tax Act of 1961, equity mutual funds are defined as mutual funds that invest a minimum of 65% of their assets in equity shares of domestic companies.
Short-Term Capital Gains (STCG): The profits obtained from selling equity mutual fund units held for less than 12 months fall under the category of Short-Term Capital Gains (STCG). As of July 23, 2024, these gains are subject to a 20% tax for transfers done on or after this date, whereas transfers made before this date are taxed at 15%.
Long-Term Capital Gains (LTCG): The gains derived from selling equity mutual fund units held for more than 12 months are categorized as Long-Term Capital Gains (LTCG). A 10% tax is imposed on gains exceeding Rs 1,25,000 in a financial year for those realized prior to July 23, 2024, and 12.5% for gains realized on or after this date.
Taxes on debt funds
Under the tax regulations, the taxation of debt mutual funds is dictated by the holding period rule:
Short-Term Capital Gains: If the units of debt mutual funds are sold within a period of 36 months (three years) from the date of purchase, the resulting gains are classified as short-term capital gains (STCG) and are subject to taxation at slab rates.
Long-Term Capital Gains: Conversely, if the units are sold after the 36-month period, the gains are categorized as long-term capital gains (LTCG) and are taxed at a rate of 20%, with the added benefit of indexation. Indexation allows for the adjustment of the gains made by investors for inflation.
Indexation benefit
The removal of indexation benefit for debt mutual funds resulted in capital gains from the sale of these funds being taxed at the recipient’s income tax slab rate. As of April 1, 2023, capital gains from debt mutual funds are now taxed according to the recipient’s income tax slab rate, with no differentiation between short-term and long-term gains.
Investments made in debt mutual funds on or before March 31, 2023, are still subject to a 20% tax rate with indexation benefits for long-term capital gains (LTCG).
How it affected investors
The capital gains from debt mutual funds purchased on or before March 31, 2023, previously taxed as long-term capital gains at 20% with indexation, will now be taxed at 12.5% without indexation. The new tax rate will be effective for transactions such as transfer, maturity, or redemption of debt mutual funds on or after July 23, 2024.
It is important to note that there is no change in the capital gain tax rules for debt mutual fund investments made on or after April 1, 2023. All capital gains from these investments will be considered short-term and taxed based on applicable income tax slab rates, regardless of the holding period.
To keep within the Rs 1.25 lakh exemption limit, investors must strategically plan their LTCG, thereby encouraging smaller investors to increase their investments for tax-free gains. Furthermore, the rise in STCG tax from 15% to 20% for listed shares may prompt investors to consider long-term trading strategies for their investments.