As the August 31 deadline for filing income-tax returns draws near, the first thing to keep in mind is that income from all sources is captured correctly. If one has sold mutual fund units and made capital gains, it would be a good idea to brush up the current tax provisions that these gains are subject to.
Till 2014, holding equity and debt mutual funds for more than 12 months was classified as a long-term capital asset. Debt fund holders enjoyed indexation benefits for three years by investing in March of year 1 and selling in April of year 2. Investors were also given an option to be taxed at the rate of 10% (without indexation) or 20% (with indexation) on the gains from sale of mutual funds.
However, from 2014, the period of holding for debt mutual funds to qualify as a long term capital asset was increased from one year to three years, just like any other capital asset. Also, investors are taxed at a flat rate of 20% after indexation. So, if debt mutual funds are liquidated within a period of three years, the gain will be added to the total income and taxed at the applicable slab rate.
Debt mutual funds are still better than fixed deposit as a long-term investment. Through indexation benefits, post-tax returns from debt mutual funds are higher. If a debt fund investor puts money in the fund in March of year one and sells in April of year 3, he can claim indexation benefit. This will bring down his tax liability considerably.
The gains can also be set off against the short-term and long-term capital losses suffered in other investments. The increase in long-term capital gains tax on debt-oriented mutual funds was done to bring parity with bank deposits and debt mutual fund products.
In bank fixed deposits, the tax is paid on the interest earned every year at a marginal rate applicable to the investor.
So, in a falling interest rate scenario, debt funds would benefit as bond prices will increase. Also, if the investment horizon is more than three years, the tax efficiency of debt funds would be better than bank fixed deposits.
Taxability of returns from mutual funds depends on a host of factors. For one, tax rate is determined on the basis of residential status of the investor. For a resident investor, the tax rate of short-term capital gains is 15% in case of equity mutual funds. For debt funds, the tax rate will depend on the investor’s tax slab. Long-term capital gains are exempt from tax in case of equity mutual funds and, for debt funds, it is 20% after indexation.
For non-residents, short-term capital gains on equity mutual funds are taxed at 15%. For debt funds, the taxability is according to the individual’s tax slab rate. However, for long-term capital gains in debt funds, the rate is 10% without indexation or 20% after indexation. Equity mutual funds where over 65% of the corpus is invested in equity and equity-related instruments will not attract capital gains tax after one year. In case of debt mutual funds, the period of holding has to be three years to qualify as long-term capital asset.
Capital gains tax explained
* For a resident investor, the tax rate on short-term capital gains is 15% in case of equity mutual funds
* For debt funds, the rate will depend on the investor’s tax slab
* Long-term capital gains are exempt from tax in case of equity mutual funds and, for debt funds, the rate is 20% after indexation
* For non-residents, short-term capital gains on equity mutual funds are taxed at 15%
* For debt funds, the taxability is as per the individual’s tax slab rate
The writer is partner
Nangia & Co. Inputs from
Neha Malhotra, manager, Taxation, Nangia & Co.