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  1. Mutual Fund Investment: How much difference does LTCG tax on MFs make to your yield?

Mutual Fund Investment: How much difference does LTCG tax on MFs make to your yield?

The Union Budget 2018 announced a flat 10% tax on long-term capital gains on equity and equity mutual fund investments. Here's how it will impact you.

Published: September 14, 2018 11:07 AM
mutual funds, mutual fund investment, mutual fund sahi hai, LTCG tax on equity, LTCG tax on mutual funds, LTCG tax on shares, LTCG tax rate You will end up paying 10% tax on LTCG when you redeem your equity fund corpus.

After a gap of almost 15 years, the Union Budget 2018 imposed capital gains tax on long-term capital gains (LTCG). The budget announced a flat 10% tax on long-term capital gains on equity and equity mutual fund investments. Till March 2018, LTCG on equities and equity funds were entirely tax-free in the hands of investors. Effective April 2018, however, LTCG from equity funds and direct equities will be exempt only up to Rs 1 lakh per financial year. Any LTCG beyond that amount will lead to a tax of 10% on these excess capital gains. Remember, this is a flat tax, so there is no benefit of indexation available to equity funds.

Understanding the basics of LTCG on equity funds

When it comes to equities and equity funds, the definition of long term capital gains is a holding period of more than 1 year. Here equity funds are classified as any fund that has holding of more than 65% in equities. Therefore, equity funds for tax purposes include diversified equity funds, index funds, sectoral funds, thematic funds, balanced equity funds and even arbitrage funds. The challenge is that indexation will not be available. For example, even if you sell shares after 20 years, the tax will be imposed at a flat rate of 10% on the capital gains. The only benefit that you will get is a basic exemption of Rs 1 lakh and any capital gains above the level of Rs 1 lakh will be taxable at 10%. The worry is that this could really impact your financial plan since you are likely to realize your gains at the end of 15-20 years from now and the capital gains component will be huge at that point of time.

LTCG hurts your corpus, but will it hurt your annualized return on investment?

There is really no rocket science to it. You will end up paying 10% tax on LTCG when you redeem your equity fund corpus. We really do not know what will be your corpus at the end of 20 years, but we can surely estimate. We also do not know whether the LTCG tax will be in existence at the end of 20 years. If it does not exist, there is no much to worry. But if it does exist, then you need to understand the implications. Let us look at how your returns and your CAGR returns will look like in the two scenarios…

Pre LTCG Tax

Amount

Post LTCG Tax

Amount

Retirement SIP monthly

Rs.10,000

Retirement SIP monthly

Rs.10,000

Tenure of SIP

25 years

Tenure of SIP

25 years

Invested in

Equity Funds

Invested in

Equity Funds

CAGR returns

12.5%

CAGR returns

12.5%

Amount Contributed

Rs.30,00,000

Amount Contributed

Rs.30,00,000

Final Corpus

Rs.20753115

Final Corpus

Rs.20753115

Long Term Capital Gain

Rs.17753115

Long Term Capital Gain

Rs.17753115

Basic Exemption

Not Applicable

Basic Exemption

Rs.1,00,000

Taxable LTCG

Not Applicable

Taxable LTCG

Rs.17653115

Tax on LTCG

Nil

Tax on LTCG at 10%

Rs.1765311

Net Corpus on hand

Rs 20,753,115

Net Corpus on hand

Rs.18,987,804

If you look at the above table, the final corpus in the post LTCG scenario is lower by over Rs 17 lakh. That surely looks like a big deal if you look at it in absolute terms. If you put things in perspective, the exemption of Rs 1 lakh is very small when we consider the massive capital gains that will result in equities over a period of time. Let us look at it differently. If your investment of Rs 30 lakh grew to Rs 1.89 crore in 25 years instead of Rs 2.07 crore, what would be the difference it makes to your CAGR returns? You will be surprised but the CAGR difference over 25 years is less than 50 basis points. That means, instead of 12.50% returns annualized, you will be earning around 12% returns on an annualized basis. If you look at in terms of the IRR, the impact is really not too material. That is the good news!

What can equity fund investors really do in the post-LTCG scenario?

There are 4 choices in front of investors in this post-LTCG tax scenario:

# Firstly, don’t get obsessed too much over this LTCG tax. As we saw in the above illustration, the impact is less than 50 basis points in terms of annual returns.

# Secondly, you can look to either reduce your final corpus or increase your monthly SIP. An increase of 7-8% in your monthly SIP contribution is good enough.

# Thirdly, you can look to gradually plan your withdrawal so that the benefit of Rs 1 lakh is either taken out as a STP into a debt plan. That is more tax effective because when you withdraw gains up to Rs 1 lakh each year, then such gains are free of LTCG.

# Lastly, you can also look to withdraw your corpus over time as a systematic withdrawal plan. That is more tax efficient than paying 10% as taxes.

(By Sandeep Bhardwaj, Chief Sales Officer, Angel Broking Ltd)

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