Short Term Capital Gain Tax (STCG) on Debt Funds

Getting started with Short Term Capital Gain Tax (STCG)

Investors usually try to understand the risk and returns before investing in a mutual fund. They want their investment in different funds to witness capital appreciation. However, a factor that many investors oversee is taxes levied on the returns.

For example- You open a fixed deposit account and earn returns at an interest rate of 8% to 9%. The returns that you gain are taxed as they earned income when you file for taxes.

The same applies to mutual funds as well. The returns earned on mutual funds too are taxed.

What are gains on mutual funds?

Mutual funds are an instrument which collects money from the investors, invests them in different funds, and offers returns. The objective of mutual fund investment depends on the guidelines of the investor and expertise of the financial organisation.

There are two forms of returns in mutual funds-

  • Capital Gains

  • Dividends

While capital gains are the profits an investor receives after selling a mutual fund unit, the dividend is the returns earned when a fund pays interest.

However, both the returns are taxed. While you only look at returns from a mutual fund, you will also need to understand the tax that you will have to pay for the profits you make. Capital gains are taxed on the hands of the investor, while the fund organisation must pay the tax on returns earned on the dividend.

What is Capital Gain?

Capital gain is an increase in the value of a fund over time. It is the difference between the purchase value of a fund and the selling value of a fund.

For example- you invested Rs. 2 Lakhs in a mutual fund in the year 2019. But in the year 2020, the value of the fund became Rs. 2.10 Lakhs. The difference of Rs. 10,000 is capital gains.

The government taxes the capital gains that you earn. The type of mutual fund and the period of the investment impact the tax. There are two types of capital gains tax, such as Long Term Capital Gains Tax (LTCG) and Short Term Capital Gains Tax (STCG).

How is Short Term Capital Gains taxed?

When an investor stays invested in a mutual fund for a short time, be it for equity funds or debt funds, the profits earned from it are short term capital gains.

Equity schemes have 65% investment in equity funds. However, when the investment in equity is less than 65%, the investment becomes a debt fund. Equity mutual funds are schemes that have a stake in shares and stocks, while debt mutual funds invest in corporate bonds, treasury bills, government securities, etc. Unlike the short-term capital gains from equity funds, the short-term capital gains from debt funds are not taxed under Section 111A.

The tax rates vary for equity funds and debt funds. Short term capital gain tax on the mutual fund for equity funds is 15%. But short-term capital gains for non-equity investments are taxed as per the income tax slab rate of the investor. An investor can adjust short term capital losses against short term and long-term capital gains.

Fund Period Tax
Equity Funds Up to 12 Months 15%
Non-Equity Funds Up to 36 Months Income Tax Slab Rate

The period of short term capital gain on a mutual fund is different for equity and debt funds. When an investor sells equity funds in 12 months after purchase, they become short term capital gains. A tax rate of 15% is applicable on the returns. But for debt fund, the period is up to 36 months. The tax rate on STCG on debt funds is as per the income tax slab of the investor. The tax rate of short-term capital gains will be 20% if the investor falls in 20% tax slab rate. The debt fund will also be charged 4% cess.

While you must research the returns of funds you want to invest in, you also need to find out how much tax you will have to pay.