Reasons Why Equity Funds Are Good Even After LTCG Tax

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Article Summary

• Investments in equity funds like Equity Linked Savings Scheme (ELSS) are eligible for tax deductions up to ₹1.5 lakh p.a. under Section 80C.

• Capital gains from equity funds of less than one year pay 15% short-term capital gains tax. This is lower than the tax on capital gains (taxed at income tax rates) for non-equity investments like fixed deposits (FDs) and debt funds.

• Capital gains on equity fund investments of more than one year pay 10% long term capital gains tax for amounts exceeding ₹1 lakh for any financial year. This is lower than capital gains taxed at the applicable income tax rate for non-equity investments.

• Equity fund investments are typically highly rewarding in the long term i.e., 8-10 years, or more. Tax regulations encourage long term equity investments, and this significantly bolsters this advantage.

Many of us are aware that equity fund returns typically provide high growth in the long term i.e., over 8-10 years, and more. Their returns tend to be more than other mutual fund and investment categories. However, what further helps drive home their advantage is the equity mutual fund taxation which helps enhance equity mutual funds returns. 

Understanding Tax on Equity Mutual Funds 

For equity fund investments, tax on equity mutual funds needs to be understood from three points of impact: contribution, returns and maturity proceeds. 

1. Equity mutual fund taxation at contribution stage

You do not get taxed on the investment amount, but you can avail of tax deductions for eligible investments. This is true for investments in Equity Linked Savings Scheme (ELSS) eligible for annual tax deductions of up to ₹1.5 lakh under Section 80C. Similar deduction is available for eligible retirement mutual funds which typically invest in a mix of debt and equity investments. This provision for tax deduction helps enhance the equity mutual funds returns.

2. Equity mutual fund taxation of returns

Mutual funds typically provide capital gains which accrue on liquidation of units. Of the five sources of income classified under income tax, they are included in the category of “income from capital gains.”  In that sense, their tax treatment is different from interest bearing or coupon payment making investments like fixed deposits (FDs) and bonds respectively, classified as “income from other sources” for income tax. For them, you pay tax according to the relevant income tax rate in the year of the income’s receipt.

3. Capital gains tax on equity mutual fund

The capital gains made from equity mutual funds is taxed depending on whether the period of investment was less than one year or more. Capital gains made on equity fund investments less than one year is considered short term capital gains on which short term capital gains tax of 15% is charged.

Capital gains made on equity mutual fund investments of more than one year are considered as long term capital gains or LTCG. In terms of taxation, long term capital gains tax is imposed on long term capital gain on equity mutual fund. LTCG on equity mutual funds till Rs 1 lakh in a financial year is exempt from long term capital gains tax while long term capital gain on equity mutual fund exceeding this amount is taxed at 10% long term capital gains tax.

Equity Mutual Fund Tax Advantage

Compared to alternatives; tax regulations are advantageous for equity funds. This is more so for those in the highest 30% tax slab. Compared to interest income taxable at the highest income tax rate, you pay 10% LTCG on equity mutual funds for long term capital gains exceeding ₹1 lakh for the financial year. 

The equity fund tax treatment provides a great incentive to stay invested for the long term to receive the typically high long term growth. In terms of a back-of-the-envelope calculation, an equity fund delivering 12% annually over 10 years, effectively gives you a return 10.8% for the taxable capital gains portion and on liquidation of units. Compare this to the annual hammering at the relevant income tax rate for interest income.

Tax regulations also allow you to square off your long term and short term capital gains against your long term losses which, on many occasions, helps you reduce taxable capital gains. What is more, you can carry forward losses for 8 financial years to exhaust them.

To conclude, compared to alternatives, regulations for tax on equity mutual funds not only encourage investors to stay invested for the long term, but also lower tax impact to enhance equity mutual funds returns.

FAQs

How are capital gains from ELSS taxed?

As each ELSS investment has a 3-year lock in, by default any capital gains are long term capital gains and thus pay 10% long term capital gains tax for amounts exceeding ₹1 lakh in any financial year.

How are dividends from equity funds taxed?

Such dividends are taxed at the relevant income tax rate. Since equity fund investments typically provide high rewards in the long term i.e., 8-10 years or more, it is better to opt for the growth option to accumulate highest possible savings.

How are capital gains from hybrid funds taxed?

Capital gains from mutual funds with 65% or more in equity investments are treated as equity funds for taxation while the rest are treated as debt funds and capital gains taxed accordingly.

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Disclaimer:        

The information set out above is included for general information purposes only and is not exhaustive and does not constitute legal or tax advice. The tax provisions mentioned in the article are for illustrative purposes only. All complaints regarding Mutual Fund can be directed towards visit www.scores.gov.in (SEBI SCORES portal). Readers are requested to make informed investment decisions and consult Chaitanya Financial Consultants – 9000628943 / mfd.mmr@gmail.com to determine the financial implications with respect to investing in Mutual Funds.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.