Mutual Funds: How Budget 2024's Capital Gains Tax rate changes will impact your MF investments. 

Budget 2024: A tweak in the Capital Gains Tax rates can have direct impact on your different assets - mutual funds, stocks, and gold investments. Finance Minister Nirmala Sitharaman said, "A beginning is being made in the Finance Bill by simplifying the tax regime for charities, TDS rate structure, provisions for reassessment and search provisions and capital gains taxation."

Long-term financial assets are assets held for more than a year. To qualify as long-term assets, non-financial assets and unlisted financial assets must be held for a minimum of two years. Unlisted bonds, debentures, debt mutual funds, and market-linked debentures will be subject to capital gains tax at the applicable rates, regardless of the holding period.

The long-term capital gains tax (LTCG) has been revised from 10% to 12.5% for both financial and non-financial assets. "For the benefit of the lower and middle-income classes, I propose to increase the limit of exemption of capital gains on certain financial assets to Rs 1.25 lakh per year," said Sitharaman.

The Short-term capital gains tax (STCG) on certain financial assets has been set at 20 per cent for certain assets "while that on all other financial assets and all non-financial assets shall continue to attract the applicable tax rate," Sitharaman said. 

Treatment of Mutual Funds

This means the Short-Term Capital Gains (STCG) tax rate on equity mutual funds was increased from 15 per cent to 20 per cent. Besides, the Long-Term Capital Gains (LTCG) tax rate on equity funds will be hiked from 10 per cent to 12.5 per cent. Finance Minister Nirmala Sitharaman further revealed that the exemption limit for LTCG tax in a financial year will be raised to Rs 1.25 lakh from the existing Rs 1 lakh.

Each Systematic Investment Plan (SIP) contribution is considered a distinct investment for tax purposes. Therefore, you are investing Rs 20,000 in an equity mutual fund through SIPs, each payment or instalment is evaluated individually to ascertain the holding period and the corresponding tax rate.

The recent rise in Long-Term Capital Gains (LTCG) tax rate from 10 per cent to 12.5 per cent may result in long-term investors facing a slightly higher tax liability. However, smaller investors could benefit from the raised exemption limit of Rs 1.25 lakh. On the other hand, the increase in Short-Term Capital Gains (STCG) tax to 20 per cent will impact those investing in short-term equity.

"The LTCG exemption limit is a saving grace. The basic exemption limit for LTCG on equity-oriented investments has been raised from Rs 1 lakh to Rs 1.25 lakh per year. Meaning, let's assume you invested in a listed financial asset for over a year and made a gain of less than Rs 1.25 lakh, you'd be excused from paying any kind of tax. In the case of unlisted financial assets, you'd have to hold the investment for at least two years," said Dhirendra Kumar of Value Research.

Hybrid Funds, Gold ETFs

The tax treatment of different Mutual Fund categories such as hybrid funds, gold ETFs, and fund of funds has been elucidated in recent clarifications. Hybrid funds holding a minimum of 65% exposure to equity are now eligible to claim Long-Term Capital Gains (LTCG) benefits after a holding period of over 24 months. Conversely, hybrid funds with 35-65% equity exposure will forfeit indexation benefits if held for more than three years.

The confusion regarding the tax treatment of Fund of Funds (FoFs) has been recently resolved in a clearer manner. From now on, FoFs will be classified as either equity funds or debt funds depending on the types of investments they hold. Specifically, Fund of Funds that predominantly invest in equity funds will now be eligible to enjoy LTCG benefits only after the completion of a holding period exceeding 24 months.

“The definition of specified MFs has however been amended and now applies only to MFs which invest more than 65 per cent of its total proceeds in debt and money market instruments. This will benefit mutual funds investing in gold, offshore securities or funds of funds as well as offshore mutual funds where the redemption proceeds will not be deemed to be short term gains now,” noted Rajesh Gandhi, Partner, Deloitte India.

"Some mutual funds were taxed as long term and short term, some mutual funds were taxed with marginal taxation rates, and some mutual funds had this concept of indexation. With this Budget, all of this gets simplified, and the concept of indexation goes away, said Radhika Gupta, Edelweiss MD and CEO of Edelweiss Asset Management Company (AMC).

She further said there will be three categories of taxation. 

> Category one is for equity and mutual funds that have more than 65 per cent equity. They are taxed as capital assets—20 per cent in the short term and 12 and a half per cent in the long term, with long-term being anything held for more than one year.

> They are funds that hold more than 65 per cent in debt securities and are taxed at the marginal rate with no concept of short-term and long-term.” 

> The third category is the one that does not fit into either category, like a gold index fund or gold ETF or could be funds of fund investing in equity fund or an international fund or could be a conservative hybrid or hybrid fund. These have taxation in the short term at marginal rate, and long term is 12 and a half per cent where the long term means more than two years.

Gupta added the second category has stayed the same as it was last year. For the third category, there is a "material benefit" for long-term investors, while remaining unchanged for short-term investors. Gupta said: "Long-term investors now face a 12.5% capital gains tax over a two-year period, instead of the marginal rate of taxation."