There are many ways of investing money in the capital market. One way is to place your money in mutual funds. Mutual fund investors receive dividends on the fund units that they hold. They may also earn a profit when the value of their holdings appreciates, leading to capital gains. The difference between your initial buying price and your selling price is your capital gain.
There are two categories of capital gains based on how long you stay invested: short-term capital gains (STCG) and long-term capital gains (LTCG). Both of these categories are taxable. The mutual fund tax rates are determined by the type of fund and the holding duration. When it comes to equities, a holding period of less than a year is short term and that exceeding a year is long term. In case of debt funds, a holding duration of up to three years is considered short term, whereas durations beyond three years are long term.
Mutual fund tax on capital gains
Let’s look at the tax rates for capital gains from mutual funds. India imposes different taxes for equity and debt funds.
STCG is taxable at 15%.
LTCG of up to Rs 1 lakh is tax-free. Any LTCG beyond the Rs 1 lakh exemption attracts a 10% tax rate.
STCG is counted as part of the investor’s total taxable income. You are taxed according to the relevant income tax slab.
LTCG is taxed at 20% after indexation.
Calculating indexed acquisition cost
What is indexation? It factors in inflation when calculating the acquisition cost. The cost of acquisition of units is adjusted according to the Cost Inflation Index (CII). Hereis the formula:
Indexed Cost of Acquisition (ICoA) = Purchase Price x (CII of Year of Sale or Purchase)
Once you factor in the ICoA, the overall cost of acquisition increases. This brings down your capital gains and, in turn, your tax liability.
How to manage mutual funds tax
- Before investing, carry out a proper qualitative and quantitative product assessment. This may help you to avoid putting your money in unsuitable funds. You will also not be forced to suddenly exit from a scheme and, thus, attract a tax liability. If required, consult a tax professional to clear any doubts.
- Avoid frequent and sporadic buying and selling of debt fund units. Calculate the tax implications before transferring from debt to equity funds or vice versa. You are taxed each time you redeem a unit. Keep a long-term goal in mind to maximise potential returns and minimise liabilities.
- Plan your investment portfolio and redemption to benefit from the LTCG exemption limit for equity funds. Remember that the maximum exemption for equity funds LTCG is Rs 1 lakh.
- Build your portfolio based on clear short-term and long-term financial objectives. If a particular fund is not performing accordingly, sell it. Move your money into investments with better potential.
You can create wealth by investing in mutual funds. India has a taxation system that you need to understand before you start investing. Paying taxes is inevitable but there are ways to reduce your tax liabilities and other costs. For instance, if you open an account with Kotak Securities, you can explore different asset classes and opt for features that help cut costs. Capital gains can increase your tax liabilities. But by being smart about your mutual fund and other investments, you will be able to manage your taxes in a better way.