The capital gains that you earn through mutual fund investment are subject to tax charges. The taxation is either in the form of Short-Term Capital Gains Tax (STCG) or Long-Term Capital Gains Tax (LTCG). In this article, let’s understand about LTCG and how to calculate the same.
A big chunk of investors who invest in mutual funds mostly have long-term investment plans. They consider a lot of factors before they invest such as the funds’ performance, their returns when the market is high, how the funds will cope with the lows of the market, the charges they will have to pay, etc. But there is another factor that many overlooks. It is the taxes levied on the returns.
The profits that you make on your mutual fund units become earned income, and almost all types of income are taxable. There are two forms of mutual fund profits. One is capital gains, and the other is dividends.
Capital gains are the income earned by selling the stocks of units that an investor holds. The tax levied on the earnings is capital gains tax. Let’s understand the concept with the help of an example.
For instance, you invest Rs.10,000 in equity funds. After a year, you sell it off at Rs. 11,000. The difference of Rs.1,000 is capital gains. It is the difference in price between purchasing and selling that determines your capital gains.
There are two types of taxes on capital gains. One is short term capital gains tax, and the other is long term capital gains tax. Short term capital gains tax is levied on funds held less than 12 months for equity funds and 36 months for debt funds.
Profits that you generate by selling your shares after 12 months are long term capital gains. Unlike short term capital gains where investors sell the shares before the completion of a year, LTCG on mutual funds can only be earned when investors sell units after a year. However, for non-equity funds, the period for short term capital gains is less than 36 months.
Long term capital loss works the way gains do. Loss due to selling units after 12 months becomes long term capital loss. Gains and loss can be adjusted when the investor files for taxes.
An investor earns long term capital gains when the profits are garnered by selling the units after a year. However, investors should hold the debt fund for more than three years before the sale.
If the profit from equity funds is more than Rs. 1 Lakh in a year, then the investor must pay 10% tax without indexation. Long term capital gains on debt funds have a different tax bracket. The capital gains are charged 20% tax with indexation. Indexation is simply determining inflation after the sale in comparison to the purchase of the units.
The taxes on hybrid debt funds
The tax benefits are more when you stay invested for a longer duration. The returns from long term gains are more tax-efficient than short term capital gains.
You can determine long-term capital gains tax using the below formula:
Long-term capital gain = full value of consideration received or accruing – (indexed cost of acquisition + indexed cost of improvement + cost of transfer)
Calculation of long-term capital gains tax is tricky, as the tax takes into account the inflation factor since investors hold the fund for a longer period.