Every mutual fund investor earns returns in the form of capital gains when they redeem or sell their units. These gains are taxed differently depending on how long you hold your investment. Two terms you’ll frequently come across are Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG). In July 2024, the Indian government revised the taxation rules — making it important for investors to understand the new changes.

What Are Capital Gains?

Capital Gains: The profit earned when you sell your mutual fund units at a price higher than the purchase cost.

Two types:

• STCG (Short-Term Capital Gains): When units are sold within a short period.

• LTCG (Long-Term Capital Gains): When units are held for a longer period before selling.

STCG vs. LTCG in Equity Mutual Funds

Key Points:

• STCG is always taxed — there’s no exemption limit.

• LTCG is tax-friendly due to the exemption threshold. Earlier it was ₹1,00,000, now raised to ₹1,25,000.

Taxation on Non-Equity / Debt Mutual Funds

• For investments made on or after 1 April 2023:

o Both STCG and LTCG are taxed as per your income tax slab.

o No indexation benefit is available.

• For investments made before 1 April 2023:

o STCG = taxed as per your income tax slab.

o LTCG = taxed at 20% with indexation, which adjusts gains for inflation.

Why These Changes Matter for Investors

• Higher STCG tax (20%) makes short-term equity investing less attractive.

• LTCG exemption limit increased from ₹1 lakh to ₹1.25 lakh — a slight relief for long-term investors.

• Debt fund rules tightened — making them less tax-efficient compared to earlier.

Example for Clarity

Suppose you invested ₹5,00,000 in an equity mutual fund:

• You sold it after 8 months with a gain of ₹50,000.

o Tax = 20% of ₹50,000 = ₹10,000.

• You sold it after 18 months with a gain of ₹2,50,000.

o Exemption = ₹1,25,000.

o Taxable gain = ₹1,25,000.

o Tax = 12.5% of ₹1,25,000 = ₹15,625.

How Investors Can Plan Smartly

• Stay invested for more than 12 months in equity mutual funds to benefit from lower LTCG tax.

• Avoid frequent buying and selling, as higher STCG tax eats into returns.

• Choose the right fund type depending on your investment horizon and tax slab.

• Consult a financial advisor to align investments with tax efficiency.

Quick FAQs on Mutual Fund Taxation

Q1. Are SIP investments taxed differently?

No. Each SIP installment is treated as a fresh investment. The holding period for LTCG/STCG is calculated separately for every installment.

Q2. Are dividends from mutual funds taxable?

Yes. Dividends are added to your income and taxed as per your income tax slab.

Q3. Can I avoid paying capital gains tax by reinvesting?

No. Even if you reinvest the proceeds, the tax on capital gains is applicable.

Q4. Is indexation available for debt mutual funds now?

Only for investments made before 1 April 2023. New investments don’t enjoy indexation benefits.

Q5. Which is more tax-efficient — equity funds or debt funds?

Equity funds are more tax-efficient for long-term investors due to the LTCG exemption and lower tax rates.

Conclusion

Taxation plays a crucial role in shaping your mutual fund returns. With the new rules effective from 23 July 2024, investors need to be aware of the higher STCG tax and the revised LTCG exemption. A well-planned, long-term approach not only maximizes wealth but also minimizes tax liability.