Long Term Capital Gain Tax on Shares and Mutual Funds

The finance minister re-introduced the long-term capital gain (LTCG) tax in the budget for the financial year 2018-19. It is proposed that investors have to pay 10% Long term capital gain tax on shares and mutual funds.

Earlier there was no LTCG tax on stocks and equity mutual funds which attracted many investors for long-term investing. The Short-term capital gain tax shall be 15% as before. The only change has happened in the budget is LTCG tax on equity and equity oriented mutual funds.

Capital Gain:                                                                             

When you make profit on selling of stocks and mutual fund is called as capital gains. Depending on the holding period of capital assets it is classified as Short-term capital gain (STCG) and Long-term capital gain (LTCG). If the holding period is less than 1 year the value appreciated is called as STCG and LTCG for the holding period of more than 1 year.

For the Stocks and equity mutual funds, the STCG tax is 15% on the gains and LTCG tax is 10% without indexation benefit. Remember that the tax treatment of debt mutual funds has not been changed in this budget.

Long Term Capital Gain Tax:

The finance minister has proposed in the budget 2018-19 that the long-term capital gain tax of 10% over Rs 1 lakh gain without any indexation benefit. However, all gains up to 31st January 2018 will be grandfathered.

Example:

  • You have bought an equity share before 31st January 2018 let’s say 25th April 2017 at a price of Rs 500. The stock price on 31st January is Rs 650. If you sell the stock after one year of holding at a price of Rs 750 the LTCG tax will be on the gain of Rs 100 (Rs 100=750-650).
  • Remember you have to pay tax if the gain is more than Rs 1 lakh in a financial year. Suppose you have capital gain of Rs 1.5 lakh in a financial year. The applicable LTCG tax will be on Rs 50,000(Over and above Rs 1 Lakh) only i.e. Rs 5000.

From the above example, it is clear that the deciding the buying price or the cost of acquisition is very important to calculate the capital gain tax.

According to budget, the cost of acquisition (Assets acquired before 1st February 2018) would be the higher of the followings.

  1. The actual cost of acquisition and
  2. The lower of
  • The fair market value
  • The full value of the consideration received or accruing as a result of the transfer of the capital asset.
Other than the above example we will look into different cases and how the LTCG shall be calculated.
  1. You have bought an equity share before 31st January 2018 let’s say 25th April 2017 at a price of Rs 500. The stock price on 31st January is Rs 650. After that, the stock price is down and you sell the stock after one year of holding at a price of Rs 600. Here the sale value is lower than actual cost of acquisition and fair market value on 31st January 2018. In this case, the LTCG tax will be NIL (Rs 600-Rs 600) as the sale value has been considered as the cost of acquisition.
  1. Suppose you have bought an equity share on 25th April, 2017 at Rs 500. The fair market value of the stock on 31st January 2018 is Rs 400. Here the actual cost of acquisition is to be considered for calculating the long-term capital gain. If the selling price of the stock is Rs 650 the LTCG =Rs 150 (Rs 650- Rs 500).
  1. You have bought an equity share on 25th April 2017 at a price of Rs 500 and the fair market value on 31st January 2018 is Rs 600 and you sell the stock after one year at a price of Rs 400. Here the sale value is less than the actual cost of acquisition as well as fair market value on 31st January 2018. So the purchasing price of Rs 500 is considered as the cost of acquisition. Here the Long Term capital gain = -Rs 100 (Rs 400 – Rs 500) or we can say the Long-term capital loss is Rs 100.

Long Term capital gain tax calculation

Indexation Benefit:

Indexation is the inflation adjusted price of the stock which you have purchased. With this method, your purchase price is actually more than the actual purchase price hence the capital gain is less. This indexation benefit for calculating the cost of acquisition is not applicable to equity mutual funds and stocks. This is applicable for debt mutual funds as earlier.

Long Term Capital Gain Tax on Equity Mutual funds:

The LTCG tax is applicable to pure equity funds and funds which have at least 65% of asset is in equity. The balanced funds have the tax burden as they are exposed to equity as assets of more than 65%. The debt mutual funds are having the same tax treatment as before.

Now we will look into the LTCG tax on mutual funds in detail. There are two types of mutual fund you can buy i.e. growth and dividend type.

For growth type mutual fund the tax calculation is same as direct stocks. It is also described in the various scenarios. To calculate the capital gain tax you need to be handy with the NAVs of funds on 31st January 2018. As the capital gain till 31st January is grandfathered your capital gain calculation is to be based on the same.

Many of you can think what about the dividend type mutual funds. The dividend from stock is tax-free in the hands of investors. The dividend from equity mutual fund was tax-free. The finance minister has introduced a 10% dividend distribution tax (DDT) on equity oriented mutual funds in the budget. This has been done to equalize the tax treatment of growth as well as dividend mutual funds.

However, the dividend is tax-free in the hands of investors. Investors don’t need to pay any tax on dividend. The fund houses deduct the DDT and after that, they pay to the investors. So you have to be careful enough when choosing the mutual funds whether it is dividend or growth type.

If you don’t need any regular income it is suggested not to go for the dividend type mutual fund as the fund house will deduct DDT every time they declare a dividend.

How to avoid Long Term Capital Gain Tax?

How can you reduce your LTCG tax burden on stocks and mutual funds investment? The introduction of LTCG is obviously reducing your effective return on the investment. To compensate the amount, you need to add your SIP amount to achieve the goal for which you are saving.

There is no LTCG tax up to 31st March 2018. If you are selling any stocks or mutual funds before 31st March you don’t have to pay LTCG tax. If you redeem mutual fund in the financial year 2018-19 and it is having long-term capital gain you have to pay LTCG tax.

Also, remember that the capital gain is calculated considering the grandfathering up to 31st January clause. It certainly reduces your tax burden.

Moreover, the capital gain up to Rs 1 lakh in a financial year is tax-free. You can sell some of the stocks and funds to leverage the benefit and again buy to reduce the tax burden. But is extremely cumbersome and one must be for a common investor to keep track and calculate accordingly.

Regular churning of the portfolio to save tax may not be helpful to every investor. The price movement may not be in your favor as well as the brokerage charges to be paid every time you buy and sell the stocks.

Generally, you should not redeem the mutual funds just to save tax. But you can think of rebalancing the portfolio. The stocks and funds which are not performing well this is the best time to get rid of those.

Conclusion:

The LTCG tax is surely reducing your effective return from stocks and mutual funds. Either you have to increase your SIP or you have to defer the period to achieve the financial goal as long as the LTCG tax is applicable.

Keep the SIP on and don’t redeem till you really need the money, may be after some years the LTCG tax is stopped again. 🙂

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