Last Updated : Feb 20, 2018 10:55 AM IST | Source:

Mutual fund Vs Ulip: Does LTCG on equities and MF make Ulips a better investment bet?

Long-term capital gains were tax free in the hands of the investor before Budget 2018.

Harjot Singh Narula

Harjot Singh Narula

Long-term capital gains are the gains arising from the transfer of the long term capital asset and long term is considered as a holding period of more than one year from the date of purchase.

There is a lot of buzz regarding long-term capital gains post Union Budget 2018. The apparent reason is that the union budget 2018-19 introduced “Long Term Capital Gains (LTCG) tax” for selling equity or equity mutual fund (MF) units or units of a business trust.

Contrasting Facts on Long Term Capital Gains:

Long term capital gains were tax free in the hands of the investor before this Budget. LTCG tax was abolished in the year 2004 to promote long-term investments and accelerate the participation of investors in the equity markets. It was then replaced by security transaction tax (STT). Only short-term capital gains were taxed at 15%, and long-term capital gains were tax exempt in the hands of the investor.

Now, after Budget 2018, investors have to pay 10% tax on the long-term capital gains on the profit reaped exceeding Rs 1 lakh from the sale of shares or equity mutual fund schemes retained for more than a year from the date of acquisition. Long-term capital gains up to Rs 1 lakh is exempted from taxation still. Additionally, the indexation benefit will not be applicable while calculating taxes as it was before. In the current regime, long term capital gain (LTCG) tax and security transaction tax (STT) both coexist which makes India probably the only country to levy these twin taxes.

The long-term capital gains earned till 31 January 2018 will not attract the proposed LTCG tax. It is also known as "grandfathered clause". The new taxation rules will be applicable from 1st April 2018.

Example: If an investor bought equity shares worth Rs 2 Lakh on 1st Jan 2016 and sold the shares for Rs Rs 3.6 Lakhs on 15th Jan 2018 (before 31st Jan 2018). The long term capital gain in this scenario is Rs 1.6 Lakhs. The applicable LTCG tax of 10% as per the current proposal will be for the capital gain exceeding Rs 1 lakh which is Rs 60,000 (Rs 1,60,000-1,00,000). But this will be tax free. However, with effect from 1st April 2018, the long- term capital gains will be duly taxed as the new laws.

Investor’s Dilemma

This tectonic change in the LTCG tax structure has brought disappointment to the investors who possess an adequate risk appetite to invest in equity markets. Investment in equity has been looked upon as the best avenue for the wealth creation beating the inflationary impacts. The retail investors who were dependent on dividends as a source of income are unhappy with this stinging move by the government. Investors take a higher risk by investing in equities to gain potential rise in the investment value. Such gains (either from direct trading or through mutual fund schemes) would shrink with the implementation of LTCG tax. Coexistence of STT and LTCG tax is more aching for the investor.

It could lead investors to move away from investing directly in equities or through equity mutual fund schemes to earn potential returns. Investors must introspect their investment portfolio and relook at their investment strategy towards a wealth building investment option with no tax incidence on the earnings from equity.

ULIP emerges as a tax exempted Investment Instrument

Another opportunity for the investors who are looking for an avenue to get returns through equity linked mechanism is “Unit Linked insurance plans” (ULIPs). The unit linked insurance plan is a combination of life insurance plus investment. ULIPs offer multiple fund options which allow the investor to choose between debt, equity or a mix of both for the investment as per his/her risk appetite for wealth creation. Investment options under ULIPs are similar to mutual funds, and an investor doesn’t have to pay LTCG tax, unlike Mutual Fund.

The catch here is that the gains from investing in equity through a unit linked insurance plan is exempt from LTCG tax as per the current regime which is a substantial pull factor in favor of ULIPs. ULIP enrich the investors with a bundle of additional tax benefits. Maturity proceeds under ULIP are tax exempted under section 10 (10 D) of the Income Tax Act (if the premium during the term of the policy is less than 10% of the sum assured). Also, the premium paid for ULIP is tax exempted up to the limit of Rs 1.5 Lakh under section 80 C of the Income Tax Act.

With the regulator’s intervention in the year 2010, ULIPs have been made more customer friendly with some overhauling changes such as capping the overall charges, extending the lock-in period from 3 to 5 years, hike in minimum life cover, etc.

ULIP being an investment cum insurance plan offers financial security in case of eventualities to provide financial support to the family members of the deceased.With its switching and redirection features, it allows the investor to transfer their funds from one fund to another based on market volatility to ensure optimum performance of the invested amount. Partial withdrawals can also be done under ULIP in the times of need which are again free from tax. ULIPs allows investors to boost their investments through loyalty additions which are additional units allocated at specified years before maturity.

Since ULIPs have a lock-in period of five years, it encourages investors for a long term investment tenure, which will be fruitful to attain higher returns fulfilling their medium to long term financial objectives.

In a nutshell, with the introduction of LTCG tax on equities, ULIPs have emerged as more tax-efficient and wealth creating investment tool for the investors looking for potential gains from equity holdings.

The writer is Founder & CEO of
First Published on Feb 20, 2018 10:49 am
Follow us on
Available On
PCI DSS Compliant