Avail tax rebate under 87A for all the capital gains except LTCG on equity

Mutual funds are like a departmental store where many products are on display and everyone can get products suitable to their needs, risk appetite and investment horizon. There are products for parking your surplus funds overnight and products that let you invest for decades. Just as the products by MFs differ, so does the tax treatment of these MF products. Let us discuss the tax treatment of the various categories of MFs. 

MF categories

For the purpose of taxation, all MF products can be divided in two broad categories equity-oriented funds and debt and gold funds, etc.

Any MF scheme which invests minimum 65% of its investible corpus in shares of domestic companies listed in Indian stock exchanges qualifies as equity-oriented fund. It also includes exchange-traded funds (ETF), which invest minimum 90% of total proceeds in other fund, which, in turn, invests minimum 90% of its proceeds in equity shares of domestic companies. 

All other MF schemes that do not fall in the equity-oriented funds category fall under the other category. This includes liquid funds, short-term bond funds, income funds, G-Sec funds, fixed maturity plans (FMPs), etc. Likewise, all gold ETFs, gold saving funds, all other fund of funds fall in this category. The funds which invest in foreign companies or funds also fall in the second category. 

Holding period requirement

Tax liability on sale or redemption of such funds depends on the holding period, again classified as long term or short term. For equity-oriented schemes, if the investment is held for over 12 months, it becomes a long-term capital asset. Profits made on it are taxed at a concessional rate. For other MFs, the holding period requirement is more than 36 months for qualifying as long term. 

In case of equity funds, if the holding period is for 12 months or less, any profit on the sale of such units is treated as short term. For other funds, the profits are taxed as short term if sold within 36 months. 

Many retail investors invest in MFs through systematic investment plans (SIPs), especially in equity products. Hence, it is important to understand how the holding period for SIP would be calculated. For investments made through SIP, each SIP is treated as separate investment, and thus, the holding period will be computed with reference to the units allotted on respective dates of SIP. So in case one does SIP in equity-oriented funds for one year, only the units allotted on the first SIP would become long term after one year of commencement of SIP. Likewise, for the units allotted on 12th SIP, you will have to wait for one year to qualify the units allotted on 12th SIP as long term.

Tax rates and exemption

Dividends received from all MFs are fully exempt in the hands of the recipient as the dividend distribution tax is already paid by the MF house at the time of payment of dividends.

As far as profits on sale and redemption of equity-oriented units are concerned, the short-term capital gains are taxed at a flat rate of 15% whereas long-term capital gains are taxed at a flat rate of 10% after the initial exemption of Rs one lakh, along with profits on all listed shares. These rates will apply only if the Securities Transactions Tax has been paid at the time of redemption/sale of such units. 

For the purpose of determining the cost of equity-oriented funds, the net asset value or market value as on January 31, 2018, can be taken as cost. You are not entitled to take the benefit of indexation in respect of cost for equity-oriented mutual fund schemes.

Short-term capital gains (STCG) on sale/redemption of units of other schemes are treated like your regular income and are taxed at the slab rates applicable to you. Long-term capital gains (LTCG) on such other funds are taxed at a flat rate of 20% after applying the cost inflation index to the cost of acquisition. 

One can avail the benefit under Section 54F to save the LTCG tax by investing the net sale proceeds for buying a residential house within specified time limits in case of long-term capital gains. 

The rates of taxes and the other provisions discussed are the same whether you have invested a lump sum or through SIP except for computing the holding period as discussed earlier.

The shortfall in the basic exemption and deduction under Chapter VIA

If your total income other than the capital gain, whether short term or long term, on sale of equity-oriented schemes is less than the amount of basic exemption limit of income, the capital gain will be reduced to the extent of shortfall, for the purpose of tax computation for resident taxpayers. In case of normal long-term capital gains, this benefit is available to all the taxpayers whether resident or not. 

In respect all capital gains, except the STCG on schemes other than equity-oriented schemes, you are not entitled to claim any deduction under Chapter VIA against such capital gains. The deduction under this chapter includes deductions under Section 80 C, 80CCD, 80 D, 80TTA, 80TTB, etc.

The rebate of tax under Section 87A, which is available only to a resident individual and which has been raised to Rs 12,500 from the current year, can also be claimed against the tax liability of all the tax payable for all the capital gains except the LTCG on equity-oriented schemes subject to fulfilment of other conditions.

The writer is tax and investment expert.