With the increase in tax on the Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG) on equity-oriented funds announced in the Union Budget, a Systematic Investment Plan (SIP) of Rs 50,000 for 60 months in equity funds would result in a higher capital gains tax outgo of Rs 94,095 against Rs 77,456 at present.
In a double whammy for mutual fund investors, the government has increased STCG and LTCG on equity-oriented funds. The Union Budget on July 23 hiked the STCG tax on equity mutual funds to 20 percent from the current 15 percent, while LTCG tax now will be 12.5 percent compared to earlier, which was 10 percent on equity funds.
However, as a relief, the government increased the exemption limit for LTCG tax to Rs 1.25 lakh from Rs 1 lakh in a financial year.
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Mutual funds are one of the most preferred routes for Indian investors to gain exposure to equity markets. Monthly investments via systematic investment plans (SIPs) have remained above the Rs 20,000-crore mark ever since breaking the barrier for the first time in April 2024.
We take a look into how taxation of capital gains arising out of SIPs in equity funds will change after the Budget 2024 proposals.
Taxation of mutual funds
Each instalment of a Systematic Investment plan (SIP) is treated as a separate investment for tax purposes. For example, if you invest Rs 10,000 per month in an equity mutual fund through SIPs, each instalment will be considered separately to determine the holding period and applicable tax rate.
Keep in mind that mutual fund investments follow a First-In-First-Out (FIFO) approach in determining the tax treatment of mutual fund units redeemed.
Taxation of equity funds
With the marginal increase in LTCG from 10 percent to 12.5 percent, long-term investors might be paying slightly higher taxes. However, with the exemption limit raised to Rs 1.25 lakh, small investors will see modest benefits. The increase of STCG from 15 percent to 20 percent will impact short-term equity investors.
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"Although the tax rates are marginally increased, equity mutual funds remain an attractive investment opportunity compared to other asset classes. Therefore, we do not anticipate that the change in tax rates will significantly affect the flows towards equity mutual funds," Feroze Azeez, Deputy CEO Anand Rathi Wealth.
Here's an example of how an SIP of Rs 50,000 per month will be taxed on redemption.
Status quo on debt funds
While, the Union Budget has lowered capital gains tax rate on gold funds or gold exchange-traded funds (ETFs), overseas funds and funds of funds (FoFs), debt mutual funds would continue to be taxed at the normal income tax rate.
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According to the budget, mutual funds investing more than 65 percent of total proceeds in debt and money market instruments will be covered under Section 50AA. Therefore, exchange-traded Funds (ETFs), Gold Mutual Funds, and Gold ETFs will not be considered specified mutual funds.
We take a look at how SIP in debt funds would be taxed at different slab rates (see table).
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"The widening gap between STCG and LTCG rates is a clear incentive for longer-term holdings, which aligns with our view of creating sustainable wealth. This move is also a step towards standardising taxation across various asset classes, potentially simplifying the investment decision-making process for many," said Rajarshi Dasgupta, Executive Director, AQUILAW.
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