When Finance Minister Nirmala Sitharaman presents the Union budget later this month, investors, taxpayers, corporates, and mutual fund houses will be hopeful for some significant tweaks in the structure of the capital gains tax, which is currently not standard.
The Capital gains tax burden experienced by investors can differ depending on the type of asset and the duration it is held, often causing confusion. The government recognises this concern and is contemplating adjustments to the tax system to ensure equitable treatment across various asset categories.
In 2018, Finance Minister Arun Jaitley reintroduced a 10 per cent Long-Term Capital Gains (LTCG) tax on gains exceeding Rs 1 lakh, without allowing indexation benefits. This decision marked a significant shift from the previous regime implemented in 2004 by the then Finance Minister P Chidambaram. At that time, LTCG was made tax-exempt, while the Securities Transaction Tax (STT) continued to be imposed on all stock exchange transactions.
Currently, investors are subject to a 15 per cent short-term capital gains tax (STCG) if the holding period of listed stocks is less than a year. Conversely, if a seller realises a long-term capital gain exceeding Rs 1 lakh (with a holding period of over 12 months) from the sale of equity shares or equity-oriented units of a mutual fund, the gain will be subject to a long-term capital gains (LTCG) tax of 10 per cent (plus applicable cess).
Taxation on mutual funds can be further explained by identifying the factors that influence it. The essential factors affecting the taxes imposed on mutual funds include:
Fund types: Taxation rules vary depending on the type of mutual fund, such as Equity Mutual Fund, Debt Mutual Fund, Hybrid Mutual Fund, and others.
Dividend: The portion of profits shared among investors by mutual fund companies is known as dividends.
Capital gains: The profit realized when investors sell their capital assets at a price higher than the total investment amount.
Holding period: The duration between the purchase and sale of mutual fund units. In accordance with the income tax laws of India, holding your investment for an extended period results in a lower tax obligation. Therefore, the holding period impacts the tax rate applicable to your capital gains. Generally, the longer you hold your investment, the lower the tax you are required to pay.
Budget expectations
Most fund managers expect the government to raise the profit threshold to Rs 3 lakh from the current Rs 1 lakh so that Long Term Capital Gains (LTCG) can kick in. Experts have said that the government should strongly contemplate the possibility of removing the capital gains tax imposed on investors when transferring their investments from a regular scheme to a direct scheme.
Preeti Zende, founder of Apna Dhan Financial Services, said: “If the LTCG limit for deduction is raised from Rs 1 lakh to Rs 3 lakh, it would be a great relief. Secondly, the new tax started on debt mutual funds is detrimental to their growth. Investors demand that this new tax be reversed or at least that indexation benefit be restored for debt mutual funds.”
She added investors are required to pay capital gains tax on mutual funds when transitioning from a regular plan to a direct plan, leading many investors to prefer sticking with the regular plans. Exempting such transfers from taxation would be a significant advantage for regular investors.
The Association of Mutual Funds in India (AMFI) has also called for changes to the tax treatment of long-term capital gains (LTCG) under section 112A of the Income Tax Act. They suggested that LTCG on listed equity shares or units of equity-oriented fund schemes held for more than one year but up to three years be taxed at 10% on gains exceeding Rs 2 lakh annually, and those held for more than three years be exempt from capital gains tax altogether.
“The existing threshold limit of Rs 1,00,000 in a financial year is very low. Exemption from LTCG tax after 3 years holding period will encourage long-term investments in equities and will help channelise more household savings in to the equity markets, thus helping the Indian economy,” AMFI noted.
“To simplify the provisions and reduce disparities, the government may consider taxing all long-term capital gains arising from transfer of securities, whether listed, unlisted, debt or equity, at 10 percent plus applicable surcharge and cess without benefit of indexation irrespective of residential status of the taxpayer,” said Shalini Jain, Tax Partner, People Advisory Services, EY India.
“The government may increase the amount of capital gains which are not subject to tax since the limit of Rs 1 lakh has remained unchanged since its introduction in the Finance Act, 2018. The Central Board of Direct Taxes (CBDT) has enhanced the reporting in Annual Information Statement (AIS) of a taxpayer to also include details of sale of capital asset made by the taxpayer during the year,” Jain wrote in a column.