Equity mutual funds: How to make the right choice in new LTCG tax regime introduced in Budget 2018

Published: February 6, 2018 3:33:12 AM

Budget 2018: The proposed tax rate is 10% without any benefit of indexation. But, he provided some relief by exempting LTCG of up to Rs 1 lakh in a financial year. He, in a way, has also exempted gains made till January 31, 2018 for the investments made before July 31, 2017.

Budget 2018: The finance minister has re-introduced long term capital gains (LTCG) tax for equity and equity-oriented mutual funds in the Budget.Budget 2018: The finance minister has re-introduced long term capital gains (LTCG) tax for equity and equity-oriented mutual funds in the Budget.

Budget 2018: The finance minister has re-introduced long term capital gains (LTCG) tax for equity and equity-oriented mutual funds in the Budget . The proposed tax rate is 10% without any benefit of indexation. But, he provided some relief by exempting LTCG of up to Rs 1 lakh in a financial year. He, in a way, has also exempted gains made till January 31, 2018 for the investments made before July 31, 2017. But, we have gone back to an era of LTCG tax prevailing before 2004, and security transaction tax (STT) remains.

In addition, to maintain parity between growth and dividend plans of equity mutual funds, the dividend distribution tax (DDT) of 10% has been introduced. In the current regime, you are indifferent between growth and dividend plan from a tax perspective for a holding period of more than one year. But, now you should be careful while choosing between growth and dividend plan. Let us understand it by using the following example.

Let us look at two scenarios. First, you invest Rs 10 lakh in an equity fund in the present regime; second, you invest Rs 10 lakh in the same fund in the new regime.

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Growth vs. dividend plan in present regime

Case 1: Dividend plan

After one year, equity fund earns 10% and the NAV goes up to Rs 110. Since you have opted for dividend plan, your fund decides to transfer the 10% gains in form of dividends. It announces and pays the dividend of Rs 10 and you receive Rs 1 lakh in form of dividend. The NAV of the fund drops to Rs 100, and your portfolio value remains at Rs 10 lakh. You earn 10% on your investments.

Case 2: Growth plan

After one year, the NAV of the fund moves to Rs 110 and your investment is worth Rs 11 lakh. If you want, you can sell units worth Rs 1 lakh and create your own dividend. LTCG is exempted and there is no tax liability for you. You earn 10% on your investments.So you are indifferent between growth and dividend plan in present regime.

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Growth vs. dividend plan in proposed regime

Case 1: Dividend plan

After one year, equity fund earns 10% and the NAV goes up to Rs 110. Since you have opted for dividend plan, your fund decides to transfer the 10% gains in form of dividends. But wait a minute, now your fund cannot transfer the entire gains to you. It has to pay 10% in form of DDT (adding surcharge + cess will increase it, we ignore it for ease of understanding) and thus your fund can pay the dividend of only Rs 9 per unit. But your NAV will come down to Rs 100 and you have earned 9% and not 10%. Where does that 1% go? Of course, to the government’s kitty.

Case 2: Growth plan

After one year, again the NAV goes up to Rs 110. Since you have opted for the growth plan, the value of your investments will grow to Rs 11 lakh. If you want, you can decide to sell units worth Rs 1 lakh and create your own dividend. The LTCG, in this case, is equal to the exempted limit of Rs 1 lakh under proposed regime and you don’t have to pay any tax. The key takeaway here is that if you are planning to invest in equity mutual fund, better opt for a growth plan over dividend plan. And keep on booking long term gains up to Rs 1 lakh every year and treat is as substitute of dividend or reinvest, if you want.

Mayank Joshipura
The writer is professor & chairperson (Finance), School of Business Management, NMIMS, Mumbai

Do you know What is Finance Bill, Short Term Capital Gains Tax, Fiscal Policy in India, Section 80C of Income Tax Act 1961, Expenditure Budget? FE Knowledge Desk explains each of these and more in detail at Financial Express Explained. Also get Live BSE/NSE Stock Prices, latest NAV of Mutual Funds, Best equity funds, Top Gainers, Top Losers on Financial Express. Don’t forget to try our free Income Tax Calculator tool.

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